Understanding Home Lenders Debt to Income Ratios

Q: I was going over our budget for the new year and a question came up that I was unable to answer.
 

When it is said that your mortgage payment should not be more than 28 percent of your gross income, what does "mortgage payment" refer to?

We have some friends who have their mortgage loan, homeowner’s insurance and property taxes all lumped into their monthly payments. We have only the property taxes included our monthly payment and pay the insurance premium ourselves. Another friend has only the mortgage amount included in the monthly payment and pays the taxes and insurance premium separately.

A: When mortgage lenders talk about 28/36 debt to income ratios, they have two things in mind.

First, the 28 number refers to 28 percent of your gross monthly income. Lenders will allow you to spend up to 28 percent of your gross monthly income on your mortgage, real estate taxes, and homeowners' insurance premium.

The 36 number refers to total debt. Lenders will allow you to spend up to 36 percent of your gross monthly income on your total debt. If you don't have any other debt (including car payments, school loans, credit card or personal debt), then you can spend up to 36 percent on your mortgage payment, real estate taxes and insurance premium.

For many borrowers, lenders "escrow" their taxes and insurance premium. That means each monthly mortgage payment also includes a portion for real estate taxes and insurance. The lender keeps all this cash for you and then is supposed to make these payments (on time!) on your behalf. Some home buyers like this because it helps make sure they have enough cash to pay these bills when they’re due.

If you decided you would pay your own real estate taxes and insurance premiums, then your mortgage payment is simply that – a payment of interest owed and principal to put toward your loan balance.

But even if you decide to pay these bills on your own, they would still count toward the 28 and 36 percent of the gross monthly income ratios lenders use to determine affordability.

Hope this clears it up for you. Good luck with your budget.

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