As you start your journey to homeownership, one of the terms you may hear from your mortgage lender is debt to income ratio. Many people have never heard this term before, but it is an important aspect of obtaining a mortgage. Your mortgage lender wants to make sure you are not going to default on your mortgage payments. While your current credit history plays a role in this determination, your debt-to-income ratio also is considered.
Your debt-to-income ratio is the percentage of your gross income against the amount you are obligated to pay monthly. This means your credit card bills, car loans, life, health, and other insurance premiums may be considered, along with your anticipated mortgage payment and taxes. Generally, a lender will want your debt-to-income ratio to be at or lower than 43 percent of your income.
Calculate Your Ratio Early in the Process
Potential homebuyers can easily determine what their debt-to-income ratio is based on current mortgage interest rates and the amount they are seeking to borrow to purchase a home. To calculate the ratio, you will need the following information:
- Total annual salary — since a lender will review your taxes for the past three years, the best method is to use your most recent tax return and get your gross annual income before taxes. Once you have this number, divide it by 12 to calculate your gross monthly income.
- Monthly debt ratio — you will want to determine what debts you are obligated to pay monthly. This should include student loans, car payments, and any other debt that you expect to pay for at least five years including personal loans. Using a mortgage calculator, determine what you anticipate your mortgage payment will be including property taxes and insurance. Make sure you include all costs associated with your mortgage when using a mortgage calculator. The totals you get here will generate the total amount of your monthly debts.
- Final calculation — the final calculation will be determining your debt-to-income ratio. This is your total monthly debt divided by your gross monthly income is equal to your debt-to-income ratio.
High debt-to-income ratios can impact your ability to secure a mortgage. However, an important thing to remember is that some lenders do have some flexibility when using debt-to-income ratios. There are lenders who are exempt from the “ability to repay” rules for qualified mortgages. Talk to your mortgage lender about your debt-to-income ratio if the numbers are problematic. They can provide you with the available mortgage options based on your ratio.
