To calculate the debt-to-income ratio, mortgage lenders add the total of a borrower's monthly debt payments by his monthly income. For example a borrower who pays $3,600 for monthly debt and has a monthly income of $10,000 has a .36 debt-to-income ratio. Lenders and underwriters use this calculation to determine the ability of a borrower to repay a housing loan, notes Bankrate.
There are two types of debt-to-income ratio from which lenders gauge if the borrower can afford a new mortgage and these are front-end ratio and total-debt ratio (or back-end ratio). Front-end debt-to-income ratio is the total housing monthly payment, which include the new mortgage payments, property taxes and insurance. The total debt-to-income ratio include the housing payment added to other monthly debt payments, notes Credit Sesame.
Lenders prefer for the front-end ratio to take up not more than 28 percent of a borrower's monthly income, while the back-end ratio should ideally be no more than 36 percent of a borrower's monthly income.
The following shows a simple way to calculate total debt-to-income ratio.
- Add all monthly debt payments
- Add all monthly sources of income
- Divide total debt payments by total earnings
Add all monthly debt payments such as car loan, student loan, minimum credit card payments and child support, together with the proposed new mortgage payments.
Add all monthly income from salary, professional fees or earnings from investments.
Divide the total monthly debt payments by total monthly earnings to arrive at the debt-to-income ratio.