One of the largest parts of a mortgage pre-approval is calculating the debt to income ratio. This part helps the home buyer understand what their maximum amount can be, when looking to buy a home.
The goal is to stay under 50%, since many programs will allow you to go up to 49% debt to income ratio. This percentage is calculated by taking the total in monthly loan payments, divided over the total in gross monthly income.
Here is an example of how the debt to income ratio is calculated:
First, figure out the total in annual gross income. (before taxes)
Let’s say someone is paid an hourly rate of $25/hour. For this example, let’s assume this person works 40 hours a week. Take $25 x 40 hours = $1000, then $1000 x 52 weeks in the year = $52,000. Then, take that annual amount of $52,000 and divide by 12 = $4333.33. This will give us the monthly gross income.
Second, figure out the total in minimum monthly loan payments you currently have, plus the new mortgage payment.
Auto payment = $350
Credit card payment = $50
Personal loan payment $100
Total = $500
Plus, the new mortgage payment. Let’s assume a $200,000 loan amount at a rate of 5% for a 30 year loan.
Principal and interest = $1073.64
Property Taxes = $325
Homeowners Insurance = $60
MI (mortgage insurance, if less than 20% down) = $100
Total = $1558.64
Grand total = $500 + $1558.64 = $2058.64
Divide the $2058.64 (total in monthly payments) over $4333.33 (total in gross monthly income) = 47.507%
That example shows the percentage under 50%, which will help in having a few mortgage options available.
By understanding this calculation, you can also figure out how much more you may qualify for, if you paid off a current loan you have. This will allow you to increase the new mortgage payment, with less current loan payments.