A Number as Useful as Your Credit Score

Looking to become a homeowner this year? Or maybe you want to sell your current home to move to a different location or into a larger property. More than likely, that means you’ll be shopping for a mortgage — a home loan that will allow you to make that move.

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

There’s another number that is just as important for evaluating your financial situation, and you don’t have to pay a fee to get it. In fact, it’s a number that you can calculate yourself anytime. Your debt-to-income ratio — 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 have 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 and interest, hazard insurance and property taxes (often referred to by the acronym PITI), private mortgage insurance (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: Yearly gross income: $45,000. Divide that by 12 to equal $3,750 in monthly income.

$3,750 x .28 = $1,050 allowed for housing expenses.

$3,750 x .36 = $1,350 allowed for housing expense plus recurring debt.

$1,350 minus $1,050 leaves only $300 per month to cover all debts other than mortgage.

This explains why a family with big student loans plus credit card debt 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 loan from the Department of Veterans Affairs, the debt-to-income ratio should not exceed 41 percent of household monthly gross income.

Staying within the lender’s debt-to-income ratio limits 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’ averaged credit score is high, a lender may allow you to carry more debt. Or he or she will suggest alternatives such as a larger down payment or finding a co-signer (never recommended by your humble columnist, as it is dangerous for both co-signers).

It’s always best to be preapproved before you begin home shopping. Now you know what your debt-to-income ratio is and what purchase price fits your budget.