Debt to Income Ratio

Your debt-to-income ratio plays an important role in determining whether or not you qualify for a home mortgage. Lenders will look at this carefully - that’s why they ask for your W-2s and pay stubs. Luckily, you can know what to expect by factoring your debt-to-income ratio beforehand. Essentially, your debt-to-income ratio is the percentage of debt that you carry on a month-to-month basis versus your gross monthly income. Here’s how you calculate it:

Calculating Debt to Income Ratio

Before you begin, tally up all your fixed monthly expenses. Don’t leave anything out, or you’ll get an inaccurate figure. Remember car payments, minimum credit card payments, student loans, child support or alimony and any other regular debt obligations. You don’t have to include things like utilities or your cable bill, since these don’t qualify as debt. Next, add your expected house payments, which should include your mortgage payments along with any private mortgage insurance, property taxes or homeowner’s insurance. Lastly, divide that by your total gross monthly income - that is, how much you get paid before taxes.

So, let’s say you make $36,000 a year in salary. Your gross income is about $3,000 per month.

And let’s say you have the following monthly expenses:

$300 in car payments
$250 in minimum credit card payments
$150 in student loans
$900 in estimated house payments (mortgage, insurance, taxes)

That’s a total of $1,600 in monthly debt. Now, let’s divide that by $3,000 and you get 53.33%. Ouch. You’re on thin ice. Here’s why:

Ideal Debt-to-Income Ratio

Private lenders prefer that you have a debt-to-income ratio below 36 percent of your monthly gross income. Anything higher, and they’ll either jack up your mortgage interest rate or deny your mortgage application outright. Your next resort is to look for an FHA loan. FHA mortgages and VA mortgages allow you to have a debt-to-income ratio up to 41 percent. As you can see, this still puts you out of range. Your options for improving your debt-to-income ratio are:

Reducing your debt by paying down credit cards and other loans.
Increase your income with a raise or second job.
Decrease your house payments by putting down a higher down payment.

Ideally, you want your housing expenses to be less than 28 percent of your monthly gross income. So, unless you want to take on a second shift, you may want to look at buying less house or coming up with a bigger down payment. With a $3,000 monthly income, your monthly house payments should be no higher than $840.

Keep this in mind as you start shopping for mortgage loans - the lower your debt-to-income ratio, the better loan you’ll get.