Debt To Income Ratios

The Rationale Behind Ratios

It's important to understand the world of ratios when considering applying for a loan. Ratios are a formula that helps lenders determine your credit-worthiness.

Debt-to-income ratio (qualifying ratio) -- Your monthly minimum debt divided by your gross monthly income, excluding mortgage or rent. The formula to calculate debt-to-income ratio is Monthly Gross Income/Total Debt Payments. So if James Smith makes $2,000 month before taxes, and his only debt is his credit cards which have a monthly minimum payment of $400, his debt-to-income ratio is 20%. ($400/$2,000 = .20)

Front-end ratio (housing expense-to-income ratio) -- Compares potential monthly mortgage payment to the gross monthly income of your total household. For example, if your mortgage payment is $600 and your household monthly income is $1800, you have a front-end ratio of 33%.

Back-end ratio (debt-to-income ratio) -- Compares your monthly minimum debt, including the estimated mortgage, to the gross monthly income of your total household.

As a general rule, if your debt-to-income ratio is low--under 20%--then your immediate financial picture looks good. Higher ratios may indicate a need to control credit and become more stable financially.