Before a first time buyer, or any home buyer sets out to start viewing properties, getting pre-approved is one of the crucial first steps, but examining your debt-to-income ratio is best done before applying for a home loan.
Why is the debt-to-income ratio of 43% such an important percentage and factor?
This ratio speaks to a home buyer’s financial capacity not so much in terms of buying a home but capacity to faithfully pay on the mortgage and not go into default – as much a concern for the lender as it should be for the home buyer.
For purposes of getting pre-approved for a mortgage, your debt-to-income ratio is calculated simply by adding up all your monthly debt payments and then divide the total by your gross monthly income. This is how mortgage lenders measure a home buyer’s ability to successfully manage monthly mortgage payments and responsible servicing of the debt.
An Example of Debt-to-Income Ratio Calculation
Let’s say your annual income is $60,000 or $5,000 monthly and the home you’re interested in is $200,000 and for the sake of simplicity, you’re putting down 3.5% as with an FHA loan at 4% interest rate.
This ratio speaks to a home buyer’s financial capacity not so much in terms of buying a home but capacity to faithfully pay on the mortgage and not go into default – as much a concern for the lender as it should be for the home buyer.
For purposes of getting pre-approved for a mortgage, your debt-to-income ratio is calculated simply by adding up all your monthly debt payments and then divide the total by your gross monthly income. This is how mortgage lenders measure a home buyer’s ability to successfully manage monthly mortgage payments and responsible servicing of the debt.
An Example of Debt-to-Income Ratio Calculation
Let’s say your annual income is $60,000 or $5,000 monthly and the home you’re interested in is $200,000 and for the sake of simplicity, you’re putting down 3.5% as with an FHA loan at 4% interest rate.
The amount you’re financing would be $193,000, add to that, again for simplicity, PMI (private mortgage insurance for loans with less than 20% down) property tax of $14 per $1,000 borrowed (check your target community’s property tax rate) and interest.
Your total monthly mortgage payment would total $1,229.89.
Now, let’s add $200 for an auto loan, $400 for revolving debt such as credit cards and accounts plus the mortgage of $1229.89. Obviously, there can be a lot more to an individual’s monthly debt than this, but we’re keeping it simple, but this totals $1,829.80.
Divide the monthly debt of $1,829.89 by the gross monthly income of $5,000 and you get a debt-to-income ratio of 36%.
Congratulations, your debt-to-income ratio is well below the general maximum of 43%.
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