How to Calculate Your Debt-to-Income Ratio

How to Calculate Your Debt-to-Income Ratio

How Much Home Can You Afford?

When you apply for a mortgage, your prospective lender will check several factors, including calculating your debt-to-income ratio in order to determine the amount of mortgage to extend to you. You can get a jump start on the home buying process by calculating your debt-to-income ratio yourself so that you have a good starting point of the price range of homes you’re likely to be able to comfortably afford.

What is a debt-to-income ratio and how is it used?

Your debt-to-income ratio is the difference between your income each month and your monthly payment obligations, and it is expressed as a percentage. Said another way, how much income do you have left over each month after paying your bills? A high debt-to-income ratio can alert prospective lenders (of all kinds, not just mortgage lenders) that an individual may be over-leveraged financially and that they may run into trouble repaying financial obligations. A high debt-to-income ratio also leaves you less wiggle room to make purchases or to repay your bills in a timely fashion if you meet with an unexpected job loss, medical expenses or similar. Lenders want to see that you are only taking on a reasonable amount of debt – that helps to protect both you and the lender.

How do you calculate your debt-to-income ratio?

Calculating your debt-to-income ratio is pretty easy:

1) add up your recurring monthly debt payment obligations and then

2) divide your total monthly gross income by the total of your monthly debt payments.

For example, if you have a monthly income of $7,000 and have monthly payment obligations of $1,500, your debt-to-income ratio is about 21%.

Different lenders will have different ratios they like to see, and that they won’t lend over. Most lenders, however, will require that you have less than 43% debt-to-income; although Fannie Mae’s HomeReady program allows up to a 50% debt-to-income ratio.

One thing to be careful of when calculating your own debt-to-income ratio, or in relying on a lender’s calculation: most lenders will only calculate your debts (your monthly payment obligations) based on those that report to a credit bureau. This means they are potentially missing other monthly payment obligations you may have such as cell phone, cable, child care, utility bills or personal loans which you didn’t finance through an institution that reports to a credit bureau (such as loans from parents or other family members or friends). You’ll want to make sure that you take those into account so that you are looking at homes within your true price range.

Additionally, when you are looking to determine “housing costs” of your prospective home, make sure that you don’t forget to include all the expenses of home ownership – not just the mortgage. You’ll need to account for property taxes, homeowners insurance, HOA fees (if applicable) and private mortgage insurance (if applicable) in addition to the principal and interest payment on a mortgage each month.

If you have questions about how to calculate your debt-to-income ratio or what factors a mortgage lender will use to get you approved for a mortgage, you should reach out to an experienced mortgage professional.

Source: Open Listings