The Importance of Your Debt-to-Income Ratio

Businessman Using Calculator

There are several ratios that lenders use in the mortgage qualification process; one of the most important of these is the debt-to-income ratio. This compares how much of certain types of debt you have to how much you earn.

Income calculations are always done on a gross, or before-tax, basis. There are actually two debt-to-income ratios that lenders are concerned with; these are called front-end and back-end ratios.

Debt calculations take into account both fixed and installment types of obligations, such as car and credit card payments. Debt doesn’t include, in all but a few instances, things like utilities, gas, and food expenses. As these don’t appear on your credit report, lenders don’t consider them in assessing your credit.

Front-end ratio

The front-end ratio includes your housing expenses (mortgage payment, taxes, and insurance) divided by your gross income. To put this in real numbers, let’s say that your gross monthly income is $4,000, and the house you are looking to purchase will carry a monthly payment, including taxes and insurance, of $1,000.

This means that your front-end ratio will be $1,000/$4,000, or 25%. However, in addition to this, you have a monthly car and credit card payments of $100 and $150, respectively, for a total of $250.

Back-end ratio

To take this to the next step, we add the $250 ($100 + $150) to the $1,000 to arrive at $1,250 per month. The new back-end ratio is $1,250/$4,000, or 31.25%.

So what does this mean to the home buyer? Lenders like lower ratios, especially when it comes to the front end. Generally speaking, your housing costs are beyond your control; however, you can work with your other debt, such as credit card and car payments. As a homeowner, you can control some portion of your ratio by controlling your debt.

Questions? Click here to contact a mortgage professional today.

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