Revealing Your Debt-to-Income Ratio

Some mortgage applicants worry when they hear about the debt-to-income ratio. Especially if you have some debt or poor credit, this term may sound alarming. It is much better to think of this ratio as an estimate of how much money you have available to pay for your loan.

Your mortgage company needs this number to help you choose the best loan option. Do not think of this as a test or a way to filter you out of the “mortgage pool”. It helps you as much as it helps the lender, because you do not want a loan that you cannot afford.

Sometimes you will see traditional loan debt limits called 28/36 qualifying ratios. The 28 and 36 are percentage numbers that translate to two interpretations or calculations of your debt.

The 28 indicates the maximum percentage of your monthly gross income that the mortgage company will allow you to use on housing expenses. This includes the principal, interest insurance, property taxes and homeowner’s association fees. Some lenders will call this the PITI.

The 36 percent is the maximum percentage of your monthly gross income that you can use towards housing expenses (in detail above) as well as recurring or expected debt payments. Debt can be credit card balances, child support or alimony, auto loans or college tuition fees.

An example of the debt-to-income ratio is as follows:
If your yearly gross income is $45,000 and you divide that by twelve, you have a monthly income of $3,750. If you multiply the $3,750 by 28 percent (.28) you get $1,050 for housing expenses. This is your 28. Next, you multiply the $3,750 monthly income by 36 percent (.36) and come up with $1,350 for housing expenses plus debt. As you can see, the second calculation estimates how much more money can be used towards debt as well as home finance expenses.

You should know that not all loans use this exact calculation. FHA loans usually use 29/41 ratios to allow a higher amount of debt. Also remember that the lender looks at this ratio as only a small part of your loan application. You will not be rejected solely on the basis of debt or poor credit, and the mortgage company wants to meet your home owning needs.