The Carr Report: Calculating Your Debt-to-Income Ratio


by Damon Carr, for New Pittsburgh Courier

When it comes to buying real estate, the 3 most important factors in determining desirability and home value are location, location, location. Most people know that. However, many people do not know this. What is the second most important factor in determining the desirability and value of real estate? This would be the square footage. Size matters!

When it comes to qualifying for a mortgage to buy a property, what are the three most important factors in determining eligibility? Some would say credit, credit, credit. Credit is a measure lenders use to gauge a person’s willingness to repay.

Thin credit or bad credit is the biggest stumbling block for people getting approved for a mortgage. Aside from credit, what do you think is the second biggest reason people don’t qualify for a mortgage? From the title of this article, I’m sure you got it right: debt to income ratio. The second most important factor in determining mortgage eligibility is what lenders call repayment capacity. Two things are assessed when determining repayment capacity: 1. Source and stability of income. 2. Debt to income ratio.

Although credit receives the glory when evaluating mortgage applications, ability to pay as expressed when assessing the debt-to-income ratio carries the most weight. Here’s why. Nobody woke up and decided on purpose – I’m going to be a deadbeat. I will accumulate credit balances, not pay them off and ruin my credit rating. In fact, people tend to be more proud of having a high credit score than having a high net worth. For the record, a high net worth trumps a high credit score. The reason people fall behind on their payments and ruin their credit is due to one of two reasons: 1. Income interruptions due to job loss, death, or disability. 2. Too much debt. They bit off more than they can chew thinking wrongly that if the lender approved me, I must be able to afford it.

You can’t assume that if a bank has approved you for a loan, you can afford it. When a bank approves you for a loan, its only concern is whether it can reasonably expect you to repay it with interest? Based on the 3 Cs of credit – character, capacity and collateral, they decide accordingly. Character or willingness to repay is assessed by reviewing credit reports and other non-credit reporting items, such as rent. Capacity or ability to repay assesses income sources and stability coupled with debt to income ratio. Collateral serves as collateral or property that can be seized in the event of non-payment, such as repossessing a car or foreclosing on a mortgage.

Understanding how to calculate your debt-to-income ratio is important. It’s a very simple calculation. I will detail how banks calculate debt to income ratios for mortgages. I will explain why the methods of calculating debt to income used by banks serve the general interest of the bank but do not sufficiently take into account all your needs, desires and objectives. Finally, I’ll walk you through a method you should use to calculate your debt-to-income ratio.

When you apply for credit, lenders assess your debt-to-income ratio (DTI) to determine the risk associated with you taking this payment in conjunction with your other debts. Your DTI is determined by dividing your total monthly recurring debt by your gross monthly income. Your gross income is the total income before taxes and other deductions from your salary.

Debts included in your DTI:

  • Mortgage (PITI)—principal, interest, taxes and insurance
  • Car payment
  • Student loans
  • Credit card
  • Personal loans
  • Credit line
  • alimony
  • Pension
  • Co-signed loans, etc.

Expenses that are not included in your DTI:

  • Utility bills
  • Insurance
  • Cable/Internet
  • Cellphone
  • Races
  • Entertainment
  • Personal care
  • Nursery
  • Personal care, etc.

Mortgage lenders look at two DTI ratios: the initial ratio and the final ratio. The initial ratio is the total mortgage payment divided by the gross income. The coverage ratio takes into account all debt payments divided by gross income. Mortgage lenders generally want you to have an initial ratio or mortgage payment to income ratio of no more than 28% of gross income. If your gross income was $5,000 per month, the total mortgage payment should not exceed $1,400 per month.

Mortgage lenders generally want your coverage ratio, or your total monthly debt, including the mortgage, to be no more than 36% of gross income. Using the same monthly gross income of $5,000, all monthly debts should not exceed $1,800 per month. I emphasize “generally speaking” when it comes to these ratios, because lenders also consider offsetting factors to justify qualifying an applicant who has an initial and final ratio above the norm. Compensating factors such as a high credit score, large down payment, strong capital position, savings, and solid investments can justify an approval with a back-end ratio as high as 55%.

Lenders have established debt-to-income ratios as a means of measuring the risk of default. I encourage you to calculate your own debt-to-income ratio to ensure that your monthly repayments do not interfere with your ability to put food on the table, pay utility bills, pay for children’s activities, save and invest for future goals and have a life.

When calculating your debt ratio, you should use net income rather than gross income. The reality is that if you make $5,000 a month, you will make about $4,000 a month. Using this will suggest that your mortgage/rent payments should not exceed $1,120 per month. The total debt or back-end ratio must not exceed 50% of your take home pay. This will put all debts, including mortgage, car payment and other loans, to a maximum of $2,000 per month. So you have at least half of your income left over to pay for utilities, buy groceries, save, invest, and have a life. Using the net income method with the initial ratio of 28% and the final ratio of 50% will ensure that you are not overstretched. This will help you maintain the necessary leeway between your income and your expenses, which will allow you to lead an abundant life, free from money worries, financial stress and money disputes. The lower your debt ratio, the higher your disposable income will be.

(Damon Carr, Money Coach can be reached at 412-216-1013 or visit his website @


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