Knowing how to calculate your debt to income ratio can help you to determine how much of a house you can shop for as you prequalify for a mortgage. The debt to income ratio is a comparison of your monthly debt to your monthly gross income and is one of the qualification requirements you must pass in order to qualify for a mortgage.
The maximum debt to income ratio you are allowed in order to qualify for most standard conventional mortgage loan programs is 45% while FHA limits you to 41%. To calculate debt to income ratio, let’s first look at debt to see what is considered debt. Then we will look at your income.
What Debt Is Included in Debt To Income Ratio?
Not all monthly debt is included in your debt to income ratio. Only institutional debt is what really counts. Institutional debt is debt like credit cards, student loans, car payments, alimony, child support, 401K loan payback, signature loans, and your mortgage payment (including home owners insurance, PMI, real estate taxes, and HOA dues where applicable). Debt that is not included in your debt to income ratio is utility bill payments, landscaping care, food, auto insurance, day care, and automobile maintenance, and possibly loan payments where you owe less than 10 payments.
What Income Is Included in Debt To Income Ratio?
Not Self-Employed – Most income that you can prove can be included in your debt to income ratio. The best scenario is where you receive a paycheck that shows gross wages before taxes are taken out. Most mortgage applications want to see your last 30 days of pay stubs to include a year to date gross wage. If you are a W-2 employee and can prove at least 30 days worth of income then your monthly income can be based on your latest job.
Self-Employed – In most cases, you can only count self-employment income if you have been self employed for at least two years. You will have to prove your income by using your last two years worth of tax returns. Some consideration might be made if you are close to your 2 year point of being self employed if you are in the same line of work as you were when you were a W-2 employee.
To Calculate Debt To Income Ratio
The equation to calculate your debt to income is easy. All you have to do is divide your monthly "institutional" debt by your gross monthly income. For example, let’s say your monthly debt totals: $2000 while your gross monthly income is $5000. This would give you a debt to income ratio of 40%.