There are constraints established by financial institutions on the size of a mortgage you are allowed to take out. The size of the mortgage, of course, will dictate the price of the house you can afford. The Consumer Financial Protection Bureau is a government agency whose job it is to make sure that financial institutions treat consumers fairly. According to the CFPB, your debt payments can be no more than 43% of your gross income:
The 43 percent debt-to-income ratio is important because, in most cases, that is the highest ratio a borrower can have and still get a Qualified Mortgage. Evidence from studies of mortgage loans suggest that borrowers with a higher debt-to-income ratio are more likely to run into trouble making monthly payments.
Here is what makes a qualified mortgage:
A Qualified Mortgage is a loan a borrower should be able to repay. Beginning on January 10, 2014, lenders making virtually any residential mortgage loan will have to assess a borrower’s ability to repay the loan. A Qualified Mortgage is presumed to meet this requirement. A Qualified Mortgage is a loan that avoids risky features and meets other requirements general, the borrower also must have a total monthly debt-to-income ratio including mortgage payments of 43% or less.
Your debt-to-income ratio is all your monthly debt payments divided by your gross monthly income. This ratio is one way that lenders measure your ability to manage your monthly loan payments. For example, let’s say your monthly debt payments look like this:
- $1500 for your mortgage
- $100 for an auto loan
- $400 for the rest of your debts
This means your monthly debt payments total $2,000. If your gross monthly income is $6,000, then your debt-to-income ratio is 33 percent ($2,000 is 33% of $6,000). Remember that your student loans must be included in this calculation, so student loans can be a drag on buying your first home.
These regulations are the direct result of the housing and mortgage crisis that lead to the Great Recession. Immediately prior to the housing bust, mortgage companies were committing vast fraud in the initiation and documentation of mortgages and then selling these mortgages to investors. Investors then lost their money in these fraudulent mortgages, and many people lost their houses because they could not make the mortgage payments.
But where did the magic number 43% come from? As I will detail below, the government-sponsored (and now government-owned) companies, Fannie Mae and Freddie Mac either own or guarantee about 60% of the residential mortgages in the United States. From an analysis of the mortgages they hold (including defaulted mortgages), Fannie Mae and Freddie Mac have determined that 43% is a safe ratio for a household.