Mortgage lenders use several tools to measure a potential home buyer’s ability to borrow. One of those measurements is the Debt To Income ratio. This ratio compares the monthly expenses to the borrower’s monthly gross income.
32/40 or what do your expenses look like…
The first measurement looks at total housing expenses and compares that to borrower’s gross income. Lenders do not want housing expenses to exceed 32 percent of monthly gross income.
Principle + Interest + Taxes + Home Insurance + Mortgage Insurance = total housing expenses.
Example: $3,200 total housing / $10,000 gross monthly income = 32 percent.
On a 30 year loan, there is roughly $700 per $100,000 depending on taxes and interest rates.
$3,200/$700 = 4.75 x $100,000 or $457,152 home loan.
The price of the home will depend on the down payment and the type of loan involved.
40 is also an important number…
Your maximum monthly debt payments should not exceed 40 percent of your monthly gross income. This would be your total housing expenses plus any of the following examples:
- Car loan
- Student loan
- Credit card payments
- Other long term payments
Any debt service that can not be paid off within 12 months will be included in this ratio.
Housing payment $3,200 plus $500 student loans, $500 Car note, plus $250 credit cards…
or $3,200 plus $1,250 = $4,450 total monthly expenses
$4,450 / $10,000 monthly income = 44.5% total debt ratio
44.5% would exceed the second 40% ratio.
To get the maximum borrowing power, when looking to buy a home, it’s important to look to reduce or eliminate as many long term debts as possible In this example, the borrower would need to eliminate $450 to get back to the required 40% ratio.
It’s not easy to eliminate monthly loan payments, but a frugal home buyer would need to make those tough decisions.