Know your ratios

When you determine the mortgage lender that you are comfortable with and that will meet your needs, the mortgage lender will then start to determine your ability to make your house payments.

One key part of determining your ability to pay is based on two ratios that all mortgage lenders use to decide whether to loan you money. The first one is a house to income ratio that helps determine how large of a house payment you can afford and the second one is a debt to income ratio that helps determine if the house payment will allow you to live a normal life and fit into your income.

The house to income ratio helps determine how much of a house payment that you can afford. Here is an example of a house to income ratio: Say you make $30,000 a year in salary, you divide this figure by 12 to get $2,500 monthly gross income. Then you multiply $2,500 times a ratio that is determined by the kind of financing you qualify for. Typical ratios for conventional loans are 28 percent. FHA loans ratios are 29 percent. Using our salary example, you would multiply $2,500 by 28 percent and come up with an affordable monthly payment of $700.

The second ratio, a debt to income ratio, determines the total amount of debt that you can afford. The ratio for debt to income with conventional loans is 36 percent and for FHA it is 41 percent. So using our example of a $2,500 gross monthly income and applying for a conventional loan, you would multiply $2,500 by 36 percent and come up with a total debt figure of $900 that you can afford each month.

So if you can afford a house payment of $700 and total debt of $900, this means that you can only afford additional debt of $200. Although these calculations may seem complex, they are an important part of lending you money and ensuring that you can enjoy your home and are not stretched beyond your means trying to make your monthly payments.