The Carr Report: Calculating your debt-to-income ratio

by Damon Carr, For New Pittsburgh Courier

When it comes to purchasing real estate, the most important 3 factors in determining desirability and home’s value is location, location, location. Most people know that. However, many people don’t know this.  What’s the next most important factor when determining desirability and value of real estate? That would be square footage. Size does matter!

When it comes to qualifying for a mortgage to purchase a property, what are the most important three factors in determining eligibility? Some would say credit, credit, credit.  Credit is a measure that lenders use to evaluate a person’s willingness to repay.

Thin credit or bad credit is the biggest stumbling block to people being approved for a mortgage. Credit aside, what do you think is the second biggest reason people fail to qualify for a mortgage? Based on the title of this article, I’m sure you got it right: Debt-to-income ratio. The second most important factor in determining one’s eligibility for a mortgage is what lenders refer to as ability to repay. Two things are being evaluated when determining ability to repay: 1. Source and Stability of income.  2. Debt-to-income ratio.

Although credit receives the glory when evaluating mortgage applications, ability to pay as expressed when evaluating debt to income ratio carry the most weight. Here’s why. Nobody woke up and decided on purpose—I’m going to be a deadbeat. I’m going to run up some credit balances, not pay it back, and ruin my credit score. As a matter of fact, people tend to take more pride in having a high credit score than they do in having a high net worth. For the record a high net worth trumps having a high credit score. The reason people fall behind on their payments and ruin their credit is due to one of two reasons: 1. Income interruptions by way of job loss, death, or disability. 2. Too much debt. They bit off more than they can chew wrongly thinking if the lender approved me, I must be able to afford it.

You cannot assume that if a bank approved you for a loan, you can afford it. When a bank approves you for a loan, their only concern is, can they reasonably expect you to pay them back with interest? Based on the 3 C’s of credit—Character, Capacity and Collateral, they decide accordingly. Character or willingness to repay is evaluated by reviewing credit reports and other items not reporting on credit reports such as rent. Capacity or ability to repay evaluates sources and stability of income coupled with debt to income ratio. Collateral serves as security or property that can be seized in the event you don’t pay such as car repossession or mortgage foreclosure.  

Understanding how to calculate your debt-to-income ratio is important. It’s a very simple calculation. I’m going to detail how banks calculate debt to income ratios for mortgage related loans. I’ll explain why the debt to income calculation methods used by banks serve the bank’s overall interest but fail to adequately take all of your needs, wants, and goals into consideration. Lastly, I’ll explain a method you should use when calculating your debt to income ratio.

When you apply for credit, lenders evaluate your Debt-to-Income ratio (DTI) to determine the risk associated with you taking on this payment in conjunction with your other debt. Your DTI is determined by dividing your total recurring monthly debts by your monthly gross income. Your gross income is total income before taxes and other deductions from your paycheck.

Debts that are included in your DTI:

  • Mortgage (PITI)—principal, interest, taxes and insurance
  • Car payment
  • Student Loans
  • Credit Cards
  • Personal Loans
  • Line of Credit
  • Child Support
  • Alimony
  • Co-signed Loans, etc.

Expenses that are not included in your DTI:

  • Utility bills
  • Insurance
  • Cable/Internet
  • Cell Phone
  • Groceries
  • Entertainment
  • Personal Care
  • Daycare
  • Personal Care, etc.

Mortgage Lenders review two DTI ratios: Front-end and back-end ratio. Front-end ratio is total mortgage payment divided by gross income. Back-end ratio takes into account all debt payments divided by gross income.  Mortgage Lenders generally want you to have a front-end ratio or mortgage payment to income ratio of no more than 28 percent of gross income. If your gross income was $5,000 per month, total mortgage payment should not exceed $1,400 per month.

Mortgage lenders generally want your back-end ratio or total monthly debt including mortgage to be no more than 36 percent of gross income.  Using the same $5,000 monthly gross income, all monthly debt obligations should not exceed $1,800 per month. I emphasize “generally speaking” in regards to these ratios because Lenders also consider compensating factors to justify qualifying a candidate who has a higher than standard front-end and back-end ratio. Compensating factors such as a high credit score, large down payment, strong equity position, robust savings and investments can justify an approval with a back-end ratio as high as 55 percent.

Lenders established debt-to-income ratios as a way to measure risk of default. I encourage you to calculate your own debt to income ratio as a way to ensure your monthly debt payments don’t hinder your ability to put food on the table, pay the utility bills, pay for children’s activities, save and invest for future goals and have a life.

When calculating your debt to income ratio, you should use net income as opposed to gross income. The reality is if you gross $5,000 per month, you’d net approximately $4,000 per month. Using this will suggest that your mortgage/rent payments should not exceed $1,120 per month. Total debt or back-end ratio should not exceed 50 percent of your net pay. This will put all debt including mortgage, car payment, and other loans at no more than $2,000 per month. Thus, you’re left with at least half your income to pay utilities, buy groceries, save, invest and have a life. Using the net income method with the 28 percent front-end ratio and 50 percent back-end ratio will ensure you’re not over extended. It will help you maintain the necessary wiggle room between your income and expenses that will afford you an abundant life, free of money worries, money stress, and money fights. The lower your debt to income ratio, the more disposable income you’ll have.

(Damon Carr, Money Coach can be reached at 412-216-1013 or visit his website @

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