Understanding How Debt Ratios Work for Home Financing
Your Debt-to-Income Ratio is the formula lenders use to calculate how much of your income can be allocated for your monthly home payment.
Your Qualifying Ratio
The formula for determining what your debt-to-income ratio is:
Current Debt + New Mortgage Payment / Gross Income
Your debt includes credit card payments, auto payments, and other revolving credit payments. It does not include phone, internet, or cable payments or utilities. This amount is then divided by your Gross income.
The easiest way to explain this is to use an example. Below are the variables:
Total Household family income – $68,000.00
Monthly Gross Income is – $5,666.66 ($68k / 12 months)
New monthly mortgage payment – $1200.00
Recurring monthly debt – $700.00
Debt $1900 / Income $5666.66 = .335 or 33.5%
Usually, a conventional loan requires a qualifying ratio of 28/36 and FHA loans, which are less restrictive, requiring a 29/41 ratio.
The first number of the qualifying ratio is the maximum percentage of your gross monthly income that can be applied to housing. (This includes loan principal and interest plus PMI, Homeowners insurance, taxes, and HOA dues.)
The second number is what percent of your gross income every month can be spent on housing costs and recurring debt together.
Using the numbers above when we plug them into these qualifying ratios, this is what we get-
- Gross monthly income of $5,666 X .28 = $1,586.48 can be applied towards housing.
- Gross monthly income of $5,666 X .36 = $2039.76 can be applied to recurring debt plus housing expenses.
With a 29/41 (FHA) qualifying ratio
- Gross monthly income of $5,666 X .29 = $1,643.14 can be applied towards housing.
- Gross monthly income of $5,666 X .41 = $2,323.06 can be applied to recurring debt plus housing expenses.
With the above example, you would qualify for a new home loan!
Remember this is just a guideline. We must also consider additional factors – such as PMI, insurance and taxes, HOA – to obtain your exact ratio. Contact one of our Mortgage Professionals to see how we can help determine how much you can afford.