What is debt to income ratio? Why does it matter when you go to buy a home?
Basically it’s a measure of how much money you make vs. how much money you pay in loan payments and housing payments each month.
So you take all the money you make in a month (before taxes), and that’s your income.
Now, take the money you will spend on housing (on your new loan) each month (including principal, interest, property taxes, homeowner’s insurance, homeowner’s association fees, and private mortgage insurance): that’s called the “front.”
Now take all your consumer debt (car payments, student loans, credit cards, boat or motorcycle loans, etc.) that you pay each month and add it to your housing payments from above. That’s called the “back.”
If you are getting a conventional loan your “front” can’t be more than 33% of your total income. That’s called the “front ratio.”
If you are getting a conventional loan your “back” can’t be more than 38% of your total income. That’s called the “back ratio.”
So for a conventional loan you need a “33/38″ debt to income ratio.
For an FHA loan, the ratio is “29/41.” In other words, you have to have a lower house payment because you have higher consumer debt.
The upshot is that this is how they figure out what loan amount you qualify for (besides credit).
Now, DO NOT go get any other loans when you are in the process of getting a loan on a house. DO NOT buy a car. DO NOT buy a motorcycle or boat. DO NOT take out a new credit card.
Why? Because it will screw up your ratios.
Let’s say you go out and buy a new motorcycle and it pushes your “back ratio” from 38% to 39% on a conventional loan. Guess what happens? You no longer qualify for the loan. Which means you can no longer buy the house you want. Which will lead to a lot of very awkward conversations with everyone involved.
You’ll also have to requalify for a new loan at a lower amount for a different home.
So pay attention to your debt to income ratio. It matters.