A Number as Useful as Your Credit Score

By Mary Hunt

February 22, 2017 4 min read

Whether you know your credit score or not, by now you are aware that you have one and that potential lenders, insurance providers and others use that three-digit number to evaluate your creditworthiness.

But there's another number that is just as important for evaluating your financial situation. In fact, it's a number that you can calculate yourself anytime.

Your debt-to-income ratio, which is expressed as a percentage, is a simple way of showing how much of your income is available for a mortgage payment after all other continuing obligations are met. This ratio is one of the many things a lender considers before approving a home loan.

If you've shopped for a mortgage loan, you've likely noticed loan debt limits referred to as the 28-36 qualifying ratio. Those numbers refer to two percentages that are used to examine two aspects of your debt load.

The first number, 28 percent, indicates the maximum percentage of your monthly gross income that the lender allows for housing expenses. It includes payments on the loan principal, loan interest, taxes and insurance (often referred to by the acronym PITI) plus private mortgage insurance (which is typically required if you will start with less than 20 percent equity in the home) and homeowner's association dues.

The second number (36 percent) refers to the maximum percentage of your monthly gross income that the lender allows for housing expenses plus recurring debt. Recurring debt includes credit card payments, child support, car loans, student loans and other obligations that will not be paid off within a relatively short period of time, typically six to 10 months.

Here's an example: A yearly gross income of $45,000 divided by 12 months equals a $3,750 monthly income. The $3,750 monthly income multiplied by 0.28 equals $1,050 allowed for housing expenses.

The $3,750 monthly income multiplied by 0.36 equals $1,350 allowed for housing expenses plus recurring debt.

Then, $1,350 minus $1,050 leaves only $300 per month to cover all debts other than mortgage. This explains why families with big student loans plus credit card debt often cannot qualify to buy a home with conventional financing.

Federal Housing Administration loan ratios are typically 29-41, allowing a higher debt load for both housing expenses and recurring debt. For a Department of Veterans Affairs loan, the debt-to-income ratio should not exceed 41 percent of household monthly gross income.

Staying within the lender's debt-to-income ratio limit is only one part of qualifying for a home loan. However, most lenders do have some leeway. If the overall picture looks good and the borrowers' average credit score number is high, a lender may allow the borrower to carry more debt or suggest alternatives, like a larger down payment or a loan co-signer (though a co-signer is never recommended by your humble columnist, as it is dangerous for both the co-signer and the co-signee).

It's always best to be pre-approved before you begin house shopping. Now you know what your debt-to-income ratio is, which will help you determine a house you can realistically afford.

Mary invites questions, comments and tips at [email protected], or c/o Everyday Cheapskate, 12340 Seal Beach Blvd., Suite B-416, Seal Beach, CA 90740. This column will answer questions of general interest, but letters cannot be answered individually. Mary Hunt is the founder of www.DebtProofLiving.com, a personal finance member website and the author of "Debt-Proof Living," released in 2014. To find out more about Mary and read her past columns, please visit the Creators Syndicate webpage at www.creators.com.

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