Debt-to-income Ratios

Real Estate

Debt-to-income Ratios

The debt-to-income ratio is the way mortgage lenders decide how much money you can afford to borrow. It is the percentage of your monthly gross income used to pay your monthly debts (not monthly living expenses). Two calculations are involved, a front ratio and a back ratio, written in ratio form, i.e., 33/38.

The first number indicates the percentage of your monthly gross income used to pay housing costs, such as principal, interest, taxes, insurance, mortgage insurance and homeowners’ association dues. The second number indicates your monthly consumer debt, such as car payments, credit card debt, installment loans, etc.

So a debt-to-income ratio of 33/38 means that 33 percent of your monthly gross income is used to pay your monthly housing costs, and 5 percent of your monthly gross income is used to pay your consumer debt—so your housing costs plus your consumer debt equals 38 percent.

33/38 is a common guideline for debt-to-income ratios. Depending on your down payment and credit score, the guidelines can be looser or tighter, and guidelines also vary according to program. The FHA, for instance, requires no better than a 29/41 qualifying ratio, while the VA guidelines require no front ratio but a back ratio of 41.

From your perspective, the debt-to-income ratio is an important number to keep an eye on. That’s because it tells you a lot about your financial situation. If your debt is, say, 60% of your income, any hit to your income will leave you scrambling. If you have to step up your spending in other areas (medical expenses, for example), you’ll have a harder time keeping up with your debt payments than someone with a DTI of 25%.

From the perspective of creditors and lenders, the DTI is an important measure of risk. Folks with higher debt-to-income ratios are more likely to default on their mortgages and other debt. When you apply for a mortgage, calculating your DTI will be part of the mortgage underwriting process. In general, 43% is the highest DTI you can have and still get a Qualified Mortgage. You want a Qualified Mortgage because it comes with more borrower protections, such as limits on fees.

Should you have any questions or if there is any way we can help, please give us a call at 931-762-4247. This is very important if you are considering trying to purchase a home.