Debt-to-Income Ratio

Calculating your debt-to-income ratio will give you an idea of how much of your income is available for monthly mortgage payments. A basic rule of thumb dictates that your total housing costs shouldn’t exceed 28 percent of your monthly gross income and that your total debt-related expenses, a combination of your housing costs and other loans, e.g., car and credit card payments, shouldn’t exceed 36 percent of your monthly gross income. Some lenders call this the 28/36 rule.

The first step in determining your debt-to-income ratio is to calculate your total annual gross income, which includes your salary and any other relevant financial resources, e.g., alimony or child support, bonuses, income from dividends and interest, or tips and commissions. Divide your annual income by 12 to get your monthly gross income. Multiply your monthly gross income by .28 and the result will give you a general idea of the monthly mortgage payment you can afford, provided that once all your debt is factored into the equation your expenses don’t exceed 36 percent of your monthly gross income.

A debt-to-income ratio is a flexible tool lenders use in conjunction with other financial information, most notably your credit score and the size of your down payment, to help calculate how much you can reasonably afford to spend on monthly housing costs. A borrower with a stellar credit score (one that is at least in the high 700s) who also is armed with a 20 percent down payment and enough cash for closing costs may get a break on a less-than-optimal debt-to-income ratio. Conversely, a borrower with a blemished credit history, a minimal down payment and who’s still scraping together the cash for closing costs may face an even stricter debt-to-income requirement.