For this section, we recommend using our mortgage calculator. I’ll also be doing step by step calculations as well so you can find out on the good old fashioned way!
- 1 Minute | No Hard Credit Check
Debt To Income Ratio And An Example
The calculation most mortgage lender use is your debt to income ratio. Your ratio is basically a percentage of your total monthly payments and your total gross income. Remember that your gross income is the amount before taxes. A healthy debt to income range is 30% or less, which means that 70% of your gross income is free to be used for food, put into savings, and added to your emergency fund.
An example calculation of debt to income:
- You have a gross monthly income of $2500, which is before taxes. This is an annual income of $30,000 a year.
- You have a car payment of $200 a month
- You have a current rent payment of $1000 a month
- You currently have a total of $100 you pay in credit card payments each month.
- This means you have a total monthly debt payment of $1300. ($200 + $1000 + $100)
- To calculate your Debt to income ratio, you will divide $1300 (your total debt payment) by $2500, and then multiply by 100%. (1300 divided by 2500 is 0.52 – 0.52 x 100% = 52%)
- You have a debt income ratio of 52%.
A debt to income ratio of 52% is very high and most home loan programs including USDA and FHA Loan programs will not lend to such a risky borrower.
If we use the above example, how low of a mortgage payment do we need to have to get to 30%? Let’s say that before you purchase your house, you pay off all of your credit card debt and pay off your car. You now have only your rent payment of $1000 counting towards you as your debt to income ratio.
- We know that 30% of $2500 is $750 (2500 x 0.30 = 750). This means that your mortgage payment would have to be no more than $750 a month to keep within that 30% range of safety.
Now that you have a mortgage payment that you know you need to stick to, you can input that amount into a mortgage calculator to see exactly how much house you can afford while still being able to save a majority of your income.
Putting It All Together
While this example has a lower mortgage monthly payment than usual, this amount can be a realistic figure if you bring a big enough down payment. The amount you are bringing towards the purchase of the house is one of the best ways to lower your monthly payment.
We’ll use another very simple example here using a mortgage calculator:
Let’s say you have a home that is $250,000, and you are going to do a 30 year loan with a 4.5% interest rate. Let’s also say that this is in a perfect setting where we are including any property taxes or homeowner’s insurance in the total value of $250,000. Figuring out how much interest you’d pay on the $250,000 purchase price for a 30 year loan is a little tougher than figuring out debt to income, so we’ll plug in those values into a mortgage calculator.
- 1 Minute | No Hard Credit Check
Your total monthly payments with interest and the principal included is at $1267. If you get another value, be sure to check $0 for property taxes, private mortgage insurance or PMI, and remove any other additional expenses that were added.
This is a little more than $500 too high for us at the moment. We want to reach our 30% debt to income threshold of $750. If we play with the numbers for the down payment on the mortgage calculator, we can arrive at $750 a month for mortgage payments if we place a $102,000 down payment, which is 41%.
This is a relatively extreme example, however we have figured out how to get to a value that we’re comfortable with. If you continue to play with the numbers, you can get an even better idea of how much house you can comfortably afford!
While this blog post was a bit more math oriented than most, we hope we have helped you learn how you can figure out how much you can afford as well as how to find out the numbers you need to make everything work.
We highly suggest playing with the mortgage calculator so you can also learn how much down payments and interest rates affect your monthly mortgage payments. It’s very fun!
