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Do you know your debt-to-income ratio?

March 10, 2008

There are two types of debt-to-income ratios, the front-end ratio and the back-end ratio.

Let’s start with the back-end ratio first.  This number, which is fairly easy to compute, shows you what percentage of your take home income is eaten up by debt.  To find your debt-to-income ratio, start by adding up your monthly payments on all long-term debts such as your mortgage, car payments, student loans, personal loans or credit cards that you will not payoff within a few months.  (Do not include daily expenses such as groceries, utility payments or entertainment expenses.)  Take that amount and divide it by your gross (take home) pay.  The percentage you are left with is your debt-to-income ratio.

For example:  Your monthly take home pay is $2,000.  Your debt payments are $800 a month.  Divide 800 by 2,000.  Your debt-to-income ratio is 40 percent.

As a general guideline, you want this number to be below 36 percent.  A higher debt-to-income ratio could make it more difficult to get loans or could impact the interest rate you are offered.

The front-end ratio is used to determine how much of your gross income will be consumed by housing expenses.  This number is calculated in a similar manner to the back-end ratio.  Take the monthly payments on your mortgage including the principal, interest, insurances and taxes.  Divide that number by your gross monthly income.

For example:  Your monthly take home pay is $4,000.  Your housing expenses are $1,100.  Divide 1,100 by 4,000.  Your front-end ratio is 27 percent.

In this case, the general guideline is that your front-end ratio should be lower than 28 percent.

Before you even start to look for a home, find out what price range you can comfortably afford by calculating your debt-to-income ratios.

The upcoming and final housing topic is what to do if you’ve already got a mortgage you can’t afford.

Written by admin · Filed Under Housing 

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