Knowledge is power. The main purpose of me providing weekly content about the mortgage industry is to help you understand a little bit more about home financing, and provide information to help level a complex playing field of data, compliance, rules, guidelines, and financial markets.
A borrower’s income-to-debt ratio is one of the big three qualifiers considered in residential lending, with the other two being credit scores and loan-to-value ratios. Knowing what makes up income-to-debt ratios will help homeowners and home buyers understand a bit more about how much they can borrow as well as how much they should borrow. Most financial advisers suggest keeping your housing expenses to 30 percent or less of your monthly income. Most lending products require a housing expense and all other eligible expenses to be 45 percent or less of monthly income, although some products allow up to 50 to 55 percent. Income ratios existing as limitations doesn’t make them targets, however. That being said, it’s important to know which expenses are included and which aren’t.
Your housing expense includes monies spent on a monthly loan payment (principle and interest), home insurance, property taxes, mortgage insurance (if applicable) and homeowners association (HOA) dues (if applicable). This total amount spent monthly is known as your housing ratio, and it’s allowed to be as high as 45 percent of your monthly income, though that amount leaves virtually no room for other forms of debt to exist. This is part of the reason for the target housing expense to exist at 30 percent or less of monthly income. In case you’re wondering, I’ve listed out several examples of monthly debts utilized in the total income to debt calculations below.
Examples of what’s included:
- Auto loans
- Student loans
- Time shares
- Credit cards
- Bank signature loans
- Boat/watercraft loans
- Other real estate loans (including home equity loans)
Examples of what’s not included:
- Car insurance
- Health insurance
- Medical bills
- Secondary education expenses
- Living (food, clothing … etc.)
- Investment deposits/expenses
The debts included are combined with your housing ratio and compared to your monthly gross income. This comprises your total income to debt percentage. Again, this needs to be equal or less than 45 percent (up to 55 percent on some loans), and to calculate your ratios (housing and total) you would use the following formula:
Housing ratio = total monthly housing payment / gross monthly income
Total income to debt ratio = monthly house payment + eligible monthly debt examples / gross monthly income
Calculating an income-to-debt ratio is part of a pre-approval process, and getting it right is important. Your loan officer should be able to do the most complex of these calculations, and if you hear a loan officer say he/she needs to double check ratios with an underwriter it probably means you have the wrong loan officer. Knowing these calculations yourself can possibly help you target the right price range before you begin your new home purchase or refinance loan search. It can help save time, and time is money!
Feel free to ask me any questions or to run through some calculations to help prepare you for your next loan. Call Mike or his team at 913.745.7000, email at firstname.lastname@example.org or visit online at www.fountainmortgage.com.
This weekly Sponsored Column is Produced by Fountain Mortgage. Located in Prairie Village, Fountain Mortgage is dedicated to educating, and thus empowering, clients to make the best financial decision possible for their situation. Contact Fountain Mortgage today.
Mike Miles NMLS ID: 265927; Fountain Mortgage NMLS: 1138268