Posted: 02/09/2007--25/11/2008 || Rate this Article: 3 || Views|| Sign In || Register ||Hello Guest
If you have recently applied for a mortgage, or if you have been looking into buying a home, youve probably heard the term debt-to-income ratio and would like to know exactly what it means.
Lenders look at a number of factors to see how likely it is that you will make your loan payments on time. One of those factors is your debt-to-income ratio. It is simply a calculation that shows how much of your gross income is reserved for loan repayment or other long-term obligations.
Your debt-to-income ratio is usually shown as two numbers (such as 28/36). The first number shows what percentage of your monthly gross income is used for housing costs. The second number shows what percentage of your monthly gross income is used for all debt payments, including your housing costs. If you are trying to meet a certain ratio to be qualified for a loan, neither of your percentages can exceed the limits provided by the lender.
Your gross income is your monthly income before any deductions for taxes, medical insurance premiums, retirement contributions or other withholdings. If you are applying for a loan with your spouse or other person, you will combine all income and debt to get an overall ratio for the two of you.
To calculate your debt-to-income ratio:
1. Divide your monthly housing costs by your monthly gross income.
If you rent, your monthly housing cost is just your monthly rent payment. If you own a home, your monthly housing costs include your monthly mortgage payment (principal and interest), real estate taxes, property insurance and homeowners association dues.
Example: Your gross monthly income is $3,000. Your monthly housings costs are $600. Your debt-to-income ratio for housing is 20%.
2. Divide your monthly debt costs (including all housing costs) by your monthly gross income.
Your monthly debt costs include the minimum required payments for your credit card accounts, student loans, automobile loans, personal loans and child support payments, as well as your total monthly housing costs.
Example: Your gross monthly income is $3,000. Your monthly housing costs are $600. You have a minimum monthly credit card payment of $90. You have a monthly payment of $200 for your automobile loan. You have a student loan with a minimum payment of $100 per month. Your total monthly debt costs are $990. Your debt-to-income ratio for all debt is 33%.
For conventional mortgages, most lenders require a debt-to-income ratio of 28/36. This means that your housing costs cannot exceed 28% of your gross income, and your total debt costs (including housing) cannot exceed 36% of your gross income. The situation provided in the examples above would meet a 28/36 required ratio.
Some lenders will allow a higher ratio, sometimes up to 50/50. This would allow up to 50% of your gross income to be reserved for debt payments. While a permitted ratio like this may allow you to purchase a much larger home than you could otherwise, be careful. The fact that a lender will approve you for a large mortgage does not mean that you will actually be able to afford the payments.
Your best bet is to sit down and prepare a detailed budget with your estimated housing costs included. Keep in mind that maintenance costs can consume a pretty significant piece of your housing budget. Once you have a good idea of how much room you actually have in your budget for housing costs, you can decide for yourself how much money you should borrow. You are the one who will have to make the payments, not the lender, so you need to be comfortable with your overall debt level.
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