What Is Debt-to-Income

• Debt-to-income ratio is the amount of your monthly income that goes toward paying your monthly debts. Your debt-to-income ratio does not include household bills such as utilities or car insurance. This ratio is used by lenders to evaluate a borrower's maximum mortgage affordability.
  
  Debt to income is generally expressed as a percentage, so the lower your debt-to-income ratio, the better you appear on paper to a lender. A low debt-to-income ratio indicates that less of your monthly income is allocated to paying bills. This is how a lender evaluates the likelihood you will repay a mortgage loan. You can control your debt-to-income by either increasing your income or lowering expenses.
  
  There are two numbers to consider when dealing with your debt-to-income ratio. Lenders evaluate the front-end number and the back-end number.
  
  

Front-End Debt to Income

• Front-end debt to income is the maximum amount of your monthly income that can be dedicated to your mortgage payment. To calculate, combine your mortgage, principal, taxes, property insurance and any mortgage insurance and association dues.
  
  Then take this number and divide by monthly income before taxes. This is the maximum amount the lender deems you can afford to allocate to your monthly mortgage payment. The generally accepted guideline for front-end debt-to-income ratio is 33 percent.
  
  

Back-End Debt to Income

• Back-end debt to income takes into account how much total debt you have and then determines how much monthly payment you can afford taking your other debts into account.
  
  To calculate your back-end debt to income, total your mortgage, principal, tax insurance, mortgage insurance (if required) and homeowner's fees (if required). You would then add to that number your car payment, credit card payment, installment loans or any other outstanding monthly debt obligations.
  
  Then divide by your total monthly income to find your back-end debt-to-income ratio. The generally accepted guideline for back-end ratio is 38 percent.
  
  

Gross Monthly Income

• Calculate debt to income by dividing your expenses by your gross monthly pay before any deductions or taxes. Take several recent paychecks and average them. To determine your monthly income, take that number and multiply by 2. This number will be your gross monthly income.
  
  If you get paid bi-weekly less frequently, or if your income is seasonal, you can find your monthly gross income using your annual income. Simply divide your annual income by 12.
  
  

Example of Debt-to-Income Ratio

• Annual income is $60,000. Car payment is $200, credit card minimums are $150.
  
  Front-end debt to income would divide annual income into months (60,000/12). Monthly gross income would be $5,000. Then multiply gross monthly income by 33 percent (5,000 times .33). Front-end debt to income would be $1,650. This is the maximum monthly mortgage payment that many lenders would approve.
  
  Back-end debt to income would include car and credit card payments. Multiply gross monthly income by 38 percent (5,000 times .38). The total amount that you could pay toward monthly mortgage and consumer debt would be $1,900. If you subtract the $200 car payment and $150 credit card payments, maximum monthly payment would be $1,550.