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Debt-to-income Ratio Really Means: What You Can Afford
Your debt to income ratio is a mathematical way of determining how much of your income should go toward your monthly mortgage payment after all your other monthly debts are paid.
Debt limit
There is generally a debt limit associated with different types of mortgages, such as the 28/36 qualifying ratio associated with conventional loans. The first number in a qualifying ratio is the maximum percentage of your monthly income that should be applied to your housing payment. When we say monthly income, we mean your gross monthly income before any withholding taxes are removed. Your housing payment includes the loan principal and interest, private mortgage insurance (if any), hazard insurance, property taxes and your homeowner's association dues (if any). Your housing payment does not include utility bills like telephone, natural gas or electrical service, or cable TV.
The second number in the ratio is the maximum percentage of your gross monthly income that underwriters will allow to be applied to your housing payment plus your “recurring debt.” Recurring debt includes any debt (again, not utility bills) that your are required to pay each and every month. This includes installment loans like car loans or student loans. It includes alimony, child support and revolving credit card payments that so many of us have these days. Even if you pay off your credit card statement every month, the underwriter will include a minimum payment in the ratios whether you like it or not.
These qualifying ratios are guidelines that mortgage lenders have used for years. Although 21st century underwriting software has modified the need for these ratios a great deal, every underwriter eventually approves your loan based on what percentage of your income is going toward your house payment. An excellent credit score can help you qualify for a mortgage even if your ratio is over and above the limit. We have seen loans of borrowers with excellent scores approved with second ratios in the 65-70% range. Incredible as it may seem, that means that 70% of your monthly income would be going toward your house payment and monthly debts. An excellent credit score makes an enormous difference when it comes to mortgages.
Understanding the qualifying ratio
A typical conventional loan will allow a qualifying ratio of 28/36, however, the second number will frequently reach 43-45% for many conventional programs. Usually an FHA loan will permit a higher debt load, reflected in a higher (29/43) qualifying ratio.
Loans for alternative credit usually pay little attention to the first number in the ratio and concentrate on the second, which will commonly reach 50-55%.
For example:
With a 28/36 qualifying ratio:
Gross monthly income of $3,500 x .28 = $980 can be applied to your housing payment.
Gross monthly income of $3,500 x .36 = $1,260 can be applied to housing payment plus recurring debt.
With a 29/41 qualifying ratio:
Gross monthly income of $3,500 x .29 = $1,015 can be applied to housing payment.
Gross monthly income of $3,500 x .41 = $1,435 can be applied to housing payment plus recurring debt.
Only guidelines
Remember these numbers are only guidelines. If you want to determine how large a mortgage loan you can afford, go to Mortgage Marketing Associates and let Bob Roscoe give you an estimate.
