Debt-to-Income Ratio Guidelines

Lenders and borrowers alike use debt-to-income ratio guidelines to calculate the percent or ratio of your pre-tax income is used to pay your debt and ensure it's at a level where you can consistently make affordable monthly payments, usually no more than 0.36, or 36 percent. Taking a few minutes to calculate your own ratio, compare it to the guidelines and learn how they're used in the loan industry can help you make decisions about your debt to qualify for better loan rates.

Debt-to-Income Ratio Defined

• Your debt-to-income ratio is the total amount of debt you pay each month divided by your gross income. For example, if you earn $50,000 a year, then you earn about $4,167 monthly before taxes. Your monthly mortgage of $1,000, car loans of $300 and student loans of $200 give you a total "recurring debt" of $1,500. Dividing your monthly $1,500 debt by your $4,167 income means your debt-to-income ratio is 0.36, that is, 36 percent of your monthly pre-tax income goes toward debt.

How Debt-to-Income Ratio Guidelines are Used

• Lenders consider your debt-to-income ratio to decide whether to lend you money because your credit score tells a lender more about your payment history than your income, although the U.S. Federal Reserve now requires credit-card companies to consider your total debt and income or assets using "a reasonable estimate" or "statistically sound models" before issuing credit. Sometimes called a "total debt" or "back-end" ratio, most lenders agree that debt is more unaffordable or difficult to stay current with payments once your debt-to-income ratio is greater than 0.36. With the exception of some FHA secured loans that allow debt-to-income ratios of up to 0.41, many lenders either don't lend past ratios of 0.36 or do so at higher interest rates. In fact, some consumers have met with the unfortunate surprise that taking out a new car loan while waiting for a mortgage approval or closing sent their debt-to-income ratios too high to qualify.

Housing Expense or Front-End Ratio Guidelines

• Another kind of debt-to-income ratio that both you as a borrower and your lender should take into account is the "housing expense" or "front-end ratio" you get by dividing your monthly mortgage payments, property taxes and homeowners' insurance by your monthly gross income. Experts usually use a 0.28 maximum ratio as a rule of thumb for an affordable mortgage payment.

Loan Modifications and Debt-to-Income Ratio Guidelines

• Borrowers seeking loan modifications try to lower their debt-to-income ratios to a level where they can pay consistently, lowering their monthly mortgage payment by extending the term of the loan or reducing the interest rate. Critics of the Obama administration's Home Affordable Modification Program like Republican congressmen Darrell Issa and Jim Jordan of the House Committee on Oversight and Reform in their August 2010 Wall Street Journal opinion article claim that these HAMP modifications aren't making payments affordable if the "median debt-to-income ratio for HAMP borrowers...remains staggering at 63.5%."

Debt-to-Income Ratio Guidelines' Effect on Loan Qualifications Nationally

• According to Harvard University's Joint Center for Housing Studies' State of the Nation's Housing 2010 report, 17.8 million renters in 2008 would have qualified for a loan at a 38 percent debt to income ratio, while only 12.5 million renters would have qualified at a 28 percent ratio. For the same number of renters to qualify with the more stringent ratio, the report suggests that median home prices would have to drop at least an unlikely 26 percent.