Demystifying Your Credit and Debt-to-Income Ratio

What is the formula for calculating how much mortgage or home you can afford? Lenders and loan officers use the guidelines of debt-to-income ratio to evaluate how much mortgage you may qualify with your other financial responsibilities and credit history. The debt-to-income ratio is based on the percentage of your household monthly gross income (before taxes) to the sum of your monthly debts.

There are two calculations used to assess how much you may qualify. A ‘front’ ratio and a ‘back’ ratio are normally devised in the following percentage format: 33/38.

The percentage of your monthly gross income prior to taxes is called the front ratio. The formula is to account for your housing costs. The mortgage home costs include principal, taxes, interest, insurance, private mortgage insurance (when applicable) and any homeowners’ association fees that may be applicable. Very similar to the front ratio, the back ratio is also includes monthly consumer debt.

Bills and payments that comprise consumer debt include automobile payments, installment loans, credit card debt, and any other similar related expenses. Both life insurance and car insurance policies are not included in the calculation; as a result, they are not deemed as debts. A consumer’s credit rating influences the interest rate a borrower may be qualified.

Because the average cost of a borrower’s home should not exceed thirty three percent of their monthly income, the debt-to-income ratios is 33/38. After the monthly consumer debt is tallied to housing costs, the total should take not be more than 38 percent of the monthly income.

While the guidelines are a basis of approving loans, the guiding principle is flexible. When a homeowner makes a nominal down payment, the guidelines are more stringent. Specifically, in cases where the lender has marginal credit, the guidelines are generally more unyielding. For the home financing seeker who makes a generous down payment or and has have superb credit, the mortgage guidelines may be more lax.

More importantly, the guidelines will vary according to the policies of the loan program. For example, with the Federal Housing Authority (FHA) the guidelines mandate that a 29/41 qualifying ratio is adequate. With a Veteran’s Administration home loan, a front ratio is non-existent; however, the guideline for the back ratio is 41 percent.