# Debt to Income Ratio Explained

Real Estate Agent with Keller Williams Realty

### Why You Can’t Buy a New Car - Yet!

By Michica Guillory, Realtor - The MyHomeHouston Team

All over Houston, people are living out their American dream and buying their own home. And all over Houston, some people are living a nightmare because they bought a new car to put into that new home…before their closing.

So, what’s the big deal? The big deal is a little thing called “debt-to-income ratio.”

This fancy term describes a lender’s simple way of illustrating what percentage of your income is available for a mortgage payment after your other major monthly debt is paid. This “other” debt might include student loans, car loans or even that Sears credit card that mysteriously keeps getting used.

In other words, this ratio tells a lender how much a home buyer can reasonably borrow and pay back. This ratio is determined at the beginning of your home buying process during pre-qualification.

Conventional loans largely have a qualifying ratio of 28/36, and these two numbers represent two different facets of your debt.

The first number represents the maximum portion of your monthly gross income – that is, before taxes – a lender will allow for essential housing expenses, including loan payments, property taxes, home owners’ association fees, private mortgage insurance and hazard insurance.

The second number represents the maximum portion of your monthly gross income that the lender allows for the debts mentioned above plus your recurring debt including auto or student loans, credit card payments and other such debts that may not be paid off quickly.

## Let's Run The Numbers

For this example, let’s say a husband and wife earn \$81,000 a year. Here’s how a lender might calculate their debt-to-income ratio for a conventional loan with a qualifying ratio of 28/36:

• Annual Gross Income = \$81,000
• Monthly Income = \$6,750

• \$6,750 x 28% = \$1890 allowed for housing expense or PITI (principal, interest, taxes & insurance)

• \$6,750 x 36% = \$2,430 allowed for PITI plus recurring debt

## Closing First, Car Last

So, if this family’s debt plus housing expenses remains at or below \$2,430, then they can be on their way to owning a home.

But if their debt suddenly exceeds this number they may destroy their chances of getting a home loan. So, if this couple buys that Nissan Altima they’ve been eyeing since the end of football season, they can say goodbye to their dream home.

And it happens all the time. Just days before meeting at the closing table, clients purchase everything from cars to refrigerators, from bedroom sets to summer wardrobes, and they forget they’re in the process of buying a home. Dreams are literally lost at the closing table.

Realtors have a saying, “If you buy a car while trying to buy a home, you just may find yourself living in that car.”

When entering into the home buying process it’s important to set priorities, get a Realtor, make a plan and stick to it!

Michica Guillory is a buyer specialist with The MyHomeHouston Team, and has been in the Houston real estate industry since 2001. She’s also the winner of a 2006 Real Estate Apprentice Foundation Grant, ranking in the Top Five.

Wayne Long
Columbus Ga Real Estate, LLC - Fort Benning - Phenix City - Fort Benning, GA
Homes for Sale In Fort Benning Ga

Good Explanation!    Usually good credit and low debt to income ratios go hand in hand.

May 17, 2007 08:39 AM
Bruce Reichstein
www.OneTimeClose.com - Houston, TX
FHA / VA One-Time Close Loans - Nationwide

It's amazing how easy it is to forget that your CURRENT spending on credit cards and other debt also affects your home loan application...once those credit reports have been pulled and the paperwork is filled out the buyer still needs to be vigilant on how they use their credit before the deal is done.

Aug 06, 2010 03:04 AM