Deciding how much debt is too much can be an important factor in determining what a healthy financial situation looks like for you. There are some simple ratios that can help you determine this. These ratios are often used by lenders to determine how much money you can borrow.

We know the term ratio sounds complex, but these are very simple to figure out using your current situation. We’ll start with the front-end ratio in today’s post.

Also known as the mortgage ratio, this will tell you how much of your income is being used up by housing expenses.

First, take your monthly mortgage payment, real estate taxes, homeowners insurance, and home equity line of credit (HELOC) minimum monthly payment (if you have one) and add them together. If you pay your taxes or insurance annually, take the most recent payments and divide them by 12 to get the monthly amount.

Once you total those expenses, divide it by your total monthly income (pre-tax). This will give you your front-end ratio.

Here is an example:

As we said, lenders often look to this ratio to determine “safe” borrowing amounts, especially when you’re trying to get a mortgage. Conventional mortgage lenders use 28% and Federal Housing Administration (FHA) uses 29% for a maximum front-end ratio. This means that if the house you want to buy puts you over those percentages, you won’t be very likely to get a loan (nor should you want to!) or may be forced into paying a higher interest rate. This incremental increase in interest may not seem large to you, but over a 30 year period could result in thousands of dollars of extra interest payments. In this example, the ratio is pushing the maximum recommended. Obviously, the lower your front-end ratio percentage is, the better off you are.

Knowing this ratio can help you in a few different situations. If you’re looking at buying a home, it can help you decide what price range to look in (mortgage) and what area to look in (taxes). If you have a drop in family income (especially due to the loss of a job) which doesn’t appear to be changing soon, it can help you evaluate if you can still afford to live in your current home. And if you are looking at taking out a HELOC, it can help you determine how much you can borrow without jeopardizing your debt load.

Next post will cover the back-end ratio, which will take into account any other debt that you have.

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