What are Debt ratios?

 

So you want to know what are debt ratios?  It is a formula that the bank uses to loan money.  The bank uses two debt ratios.  A “front end” and a “back end” debt ratio.  The bank is looking for what they consider is an acceptable percentage of your debt to income.

First debt ratio looks at how much you make compared to what you owe on your existing debts.  Anything that shows up on your credit report will be considered part of your debt.  I.E. credit card payments, car loans, and student loans.  They take all the monthly payment off the credit report and add them together.   Let’s say they add up to $650 a month and you earn $3000 a month/$36,000 a year.  So,  650/3000 = 21% debt ratio.

Then the bank adds in your monthly house payment including principal, interest, taxes, and insurance.  Let’s say that is $721 a month.  So they add $721 and $650 together and divide by $3000 monthly income to get 45.7% debt ratio.

Now I’m not going to get into whether this is good or bad because different loans have different debt ratios.  Conventional loans have one set of guidelines for debt ratios where as FHA loans have a much lenient set of debt ratio guidelines.

But know what debt ratios are and how they are calculated.  If you want more information about the home buying process click on home buyer tips on the side or first time home buyer tips to get more information.

 

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