written by: Kaye Morris•edited by: Elizabeth Wistrom•updated: 6/29/2011
Are you sick of apartment living and long for the privacy and space home ownership can provide? Do you wonder how much should your gross monthly income be to buy a house? Lenders use gross monthly income for two primary calculations to determine the maximum lending amount.
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One of the first things potential homebuyers want to know is how much should your gross monthly income be to buy a house. Understanding lending requirements before applying for a loan or looking at homes can save you the frustration and disappointment of falling in love with the perfect home that turns out to be outside of your qualifying range for lending. Lender use gross monthly income to calculate two ratios: payment ratio, sometimes referred to as “front-end" ratio, and debt ratio, sometimes referred to as “back-end" ratio. While each lender determines the ratio percentages for the calculations, a fairly common and lenient set of ratios are those required by the Department of Housing and Urban Development (HUD) in order to qualify for FHA loans.
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What is Gross Monthly Income?
In the broadest sense, monthly income is any consistent, sustainable form of pre-tax income payable to the borrower. Wages from full-time and part-time employment are gross monthly income as well as net income from self-employment and income from investments. Most lenders include alimony and child support in the gross monthly income calculation as long as the borrower can prove that the payments are bound by a legal document, such as a divorce decree, have been received on time, and are expected to continue for at least two years beyond the loan approval.
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The payment ratio is the percentage of monthly gross income that can be allocated solely to your home payment. The FHA rate that most lenders use for the payment ratio is 29 percent. That means that your total house note, including monthly principle, interest, homeowner’s insurance, private mortgage insurance and property taxes, cannot exceed 29 percent of your gross monthly income.
If your gross monthly income is $4,000, then the maximum amount of monthly mortgage payment you qualify for is approximately $1,160. By subtracting monthly estimates for property tax and insurance from the total estimated qualifying payment, you can determine the amount available for principle and interest payment. Calculating the amount of monthly principle and interest allows you to estimate your price limit for the home purchase. Affordability calculators are available for free on the Internet to assist you with those calculations.
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The debt ratio is the percentage of monthly gross income that can be allocated to all of your fixed debt. Fixed debt includes the home payment, car loans, installment loans, credit card payments and student loan payments. Fixed debt does not include utilities, insurance, gas or other expenses that are not fixed in payment and bound by a legal contract. If you have a lot of debt, the debt ratio can limit your purchasing power even if your payment ratio allows for a higher priced home.
Finally, when wondering how much should your gross monthly income be to buy a house, keep in mind that the common debt ratio used by lenders is 41 percent. To calculate your allowable debt ratio, multiply your gross monthly income by 41 percent. If your gross monthly income is $4,000, then your fixed monthly debt cannot exceed $1,640.