Debt, Income, and Your Home Loan

Your debt-to-income ratio is a key factor that lenders consider when qualifying you for a home loan.  This ratio, which shows your recurring debt as a percentage of gross income, gives lenders an idea of how much additional debt you can manage.  It therefore impacts your buying power.  So, just how does this ratio work?

Crunching the Numbers
Basically, your debt-to-income ratio is a calculation of your monthly debt divided by your gross monthly income.  For example, if you have monthly income of $5000 and debt of $2000, your debt-to-income ratio is 40 percent ($2000 divided by $5000). 

What goes into the income and debt totals used in this calculation?  Monthly income includes your regular salary, as well as other income sources such as child support or alimony or regular income from interest or dividends.  Monthly debt payments include those that are recurring, such as payments for car loans, alimony, child support, and credit card minimums.  In addition, add expected expenses for the home you are buying -- principal, interest, property taxes and hazard insurance -- to the debt total.

Examining Your Debt Load
Lenders actually look at two ratios that represent different aspects of your debt load:

  1. The first is the ratio of expected housing expenses to your monthly gross income.   Using a $5000 income figure and housing expenses of $1200 per month would yield a 24 percent ratio.
  1. The second percentage shows the relationship between your total monthly debt  (including housing expenses) and your gross monthly income.   Thus if your income is $5000, housing expenses are $1200, and other debt service is $800, this ratio would be 40 percent.

Whether the previous percentages would be acceptable debt limits will depend on the lender and the loan type.  However, a general rule of thumb for conventional loans is that lenders prefer what is known as the 28/36 qualifying ratio.  They usually like the monthly expenses for your home to be less than 28 percent of your gross monthly income.  And they prefer that your total recurring monthly obligations not exceed 36 percent of income.  You will find that loans backed by the government (FHA or VA loans) usually allow a higher debt load for both housing expenses and recurring debt.

How Much Can You Afford?
You can use the 28/36 qualifying ratio to get a ballpark figure of the monthly mortgage payment you might be able to comfortably handle.  Here is an example using the $5000 monthly income figure:

  • Amount allowed for housing expenses alone =  $1400 ($5000 x 28 percent)
  • Amount allowed for housing expenses plus recurring debt =  $1800 ($5000 x 36 percent)

Keep in mind that lenders look at other factors in addition to your debt-to-income ratio when deciding whether or not to approve you for a home loan.  These factors include your credit history, credit score, payment history, down payment, etc.  So, even if you have a high debt load, a spotless credit history and an excellent credit score might get you a little wiggle room on the acceptable debt-to-income ratio.  If you want to know for sure where you stand, get pre-approved for a loan before you begin shopping for a home.  That way you can focus your search on what you can afford.


Information is for educational and informational purposes only and is not be interpreted as financial or legal advice. This does not represent a recommendation to buy, sell, or hold any security. Please consult your financial advisor.