Debt to Income Ratio
Mortgage Dictionary -> Debt to Income Ratio
Monthly housing and debt payments divided by the gross monthly income.
When it comes time to consider how much of a mortgage you can afford, you might be confused as to how much is too much. Fortunately, there is an easy way of determining this and it's not math intensive at all. The debt-to-income ratio not only tells you how much of a mortgage you can afford, but also tells lenders how much you can really afford.
What is the Debt to Income Ratio?
It is the ratio of housing and debt payments divided by the gross monthly income. A good debt to income ratio is considered to be 0.28, although some lenders and financial experts believe a debt to income ratio of as much as 0.35 is fine as well.
How to Calculate the Debt to Income Ratio
Unlike many other financial formulas, calculating the debt to income ratio is actually really easy. You simply add up your debt and monthly housing payments and then divide this amount by your gross monthly income (which is your income after taxes are subtracted. So, if you have $500 in debt payments and $500 in monthly housing payments, this would be $1000 per month in expenses. If you make $3000 per month, you'd divide $1000 by $3000 to get the debt to income ratio of 0.30 which is considered to be either average or a little bit high.
Why the Debt to Income Ratio is Important
There are many other expenses that you probably have every month besides what you pay for your mortgage/rent and debt, so it's foolish to think a debt to income ratio of 0.50 is acceptable, as that leaves very little for your other expenses, as well as savings. It is for this reason that a debt to income ratio of 0.30 or less is considered the standard and most lenders adhere to this standard as well.
What the Debt to Income Ratio Tells Lenders
The debt to income ratio tells lenders just how much you really can afford when it comes to mortgages. It will tell them whether a $600 per month mortgage payment is OK, or if you can afford a mortgage that will cost you $1000 a month. It's probably the most important ratio there is.