DIY: Mortgage Audit
A mortgage audit is an evaluation process used by banks and other financial institutions to assess how large of a mortgage payment a person can afford each month. Getting a mortgage audit through a bank can be a lengthy and sometimes costly process. However, you can conduct your own mortgage audit to come up with an accurate idea of how much you can spend on housing each month. The mortgage audit has three components -- the front-end ratio, the back-end ratio and your credit score.
The front-end ratio is the most basic of calculations in the mortgage audit. It compares the amount of money you plan to spend each month on the mortgage to your income. As a general guideline, a mortgage should not exceed 28 percent of your monthly income pre-tax. To calculate the front-end ratio, multiply your yearly gross income by 0.28 and divide that by 12. This number is the amount you can theoretically afford to pay each month on a mortgage payment.
The back-end ratio is the complementary calculation to the front-end ratio that analyzes how much money you spend each month paying your debts and expenses, including your mortgage, car payment, student loans, credit cards and other household expenses. Ideally, your expenses should not exceed 36 percent of your monthly gross income. To calculate the back-end ratio, multiply your yearly gross income by 0.36, then divide by 12. Lenders will often compare the front-end and back-end ratios, and tend to focus on the back end, as it's a more realistic picture of your total expenditures.
Your credit score is also an important component of the mortgage audit, as it alerts the bank or financial institution to your spending and repayment habits. If you are diligent in paying your bills on time, and if you've had few or no defaults, your credit score will increase. Credit scores, or FICO scores as they are sometimes called, range from 300 to 850, and generally anything over 740 is a high score. Each year, you are allowed to obtain your credit report for free from each of the three main credit bureaus -- Experian, Equifax and TransUnion. As part of the mortgage audit, you should comb through these reports for any red flags. If there are outstanding debts or errors on the report, get in touch with the credit bureaus or debt holders, and resolve these before applying for a mortgage.
Putting It All Together
Once you've gone through your credit report and calculated both the front-end and back-end ratios, you'll have a clearer idea of your financial suitability for obtaining a mortgage. If your credit score is lower than you'd like it to be, or lower than the bank requires, or if your expenses and potential mortgage outweigh the amount you can realistically afford, consider waiting to take on a mortgage until your financial situation changes. On the other hand, if everything is in order, you can approach a lender confidently, knowing you can afford a new home and that your credit report is in good shape.
Jeremy Bradley works in the fields of educational consultancy and business administration. He holds a Master of Business Administration degree.