Debt/Income Ratios

Your debt to income ratio simply shows what percentage of your gross (before tax) income is applied to your debts. There are typically two ratios calculated with the first representing the amount of your income spent on your housing costs and the second being the total amount of your debt (including housing, auto loans, personal loans, etc.) as a percentage of your gross income.

Debt limit
There is generally a debt limit associated with each type of loan, such as 28/36 qualifying ratio for a conventional loan. This ratio would mean the lender would allow your housing costs to be up to 28% of your gross income and would allow your overall debt to be up to 36% of your gross income. These qualifying ratios are guidelines and an excellent credit history or significant cash type assets may help you qualify for a larger loan even if your debt load is over and above the stated limit.

Understanding the qualifying ratio
The first number, again being the housing debt ratio, is comprised of your principal and interest payment, taxes, insurance and private mortgage insurance if it is required. This can be calculated on a monthly or annual basis then divided by the associated monthly or annual income. The guideline is typically a maximum of 28% of your gross income, though if you have little other debt, or as stated previously, have great credit and significant liquid assets, this ratio may be allowed to go higher.

The second number is the percentage of your gross monthly income that is applied to your overall debt. This includes the total of your housing debt added to any auto payments, personal loans, student loans, credit card debt, etc. and then again divided by your gross income.

Debt ratios never include typical housing expenses such as phone bills, oil, cable bills, gas, etc.

For example:
With a 28/36 qualifying ratio:
  • Gross monthly income of $3,500 x .28 = $980 can be applied to housing
  • Gross monthly income of $3,500 x .36 = $1,260 can by applied to recurring debt plus housing expenses
Simply guidelines
Remember these are just guidelines. Banks and mortgage companies are in business to assess risk and lend you money accordingly. Based upon your risk profile they may be willing to allow your debt ratios to exceed typical guidelines. When you allow your debt to be too large a percentage of your income you are jeopardizing your overall financial health by not having funds available for investing for retirement, putting money away for college expenses, vacations, etc. Remember, what the bank is willing to lend you just means it is still a good credit risk to the bank not that it is a wise financial decision for you. It is recommended that you consider your overall goals when deciding how expensive a home you should buy or how much you should finance. I would enjoy qualifying you for your next mortgage and/or discussing the various considerations unique to your situation. Drop me an e-mail or give me a call and you can set up an appointment with myself or one of my loan officers.

Related Links:
The Loan Process
Should I get Prequalified?
Get your Loan Faster
Borrower Don'ts