How to calculate debt ratio?

Debt ratios are two numbers expressed as a percentage of your gross monthly income. The first debt ratio is called your housing ratio because it only uses your house payment (which includes your monthly tax and insurance payment) for the ratio, often also called your ‘‘front end.’’ The second ratio is your housing ratio plus any other debt listed on your credit report, divided by your gross monthly income. This is sometimes called the ‘‘back-end’’ ratio.


Common front and back ratios on conventional loans with 5 percent down are 28 percent and 36 percent. Take your gross monthly income, multiply that by 28 percent, then by using the ‘‘Cost per Thousand’’ chart in the Appendix at the back of the book you can find what a lender would consider a comfortable house payment. For example, your gross monthly income is $5,000. Remember, this is your gross income. Income before all your taxes and withholding are deducted. Let’s say that the typical housing ratio is 28 percent, historically a common housing ratio for borrowers with 5 percent down. 28 percent of $5,000 is $1,400. Included in that $1,400 is your monthly hazard insurance bill of $75 and your monthly tax payment of $125. Also note that if you put less than 20 percent down you’ll need a private mortgage insurance premium as well, which might be $85. By subtracting these amounts from your ‘‘allowable’’ $1,400, you’re left with $1,115 for your principal and interest payment.For a 30-year fixed payment of $1,115 and a note rate of 7.00 percent, the loan amount calculates to about $168,000. You’re prequalified to borrow $168,000. Give or take. Again, this is your front-end ratio.

Note that this has nothing to do with the sales price of your new home but only pertains to how much you’re going to be able to borrow. If you have a $168,000 loan amount that doesn’t mean you have a $168,000 sales price. You can have a million dollar home with just a $168,000 loan amount, as long as you have $832,000 in down payment, right?

The second ratio, or back-end ratio, is your total debt ratio and includes mostly those items that would show up on your credit report, such as automobile loans, minimum credit card payments, student loans, and the like. Other things you pay for but that are not included in your ratios are the cost of your electricity, telephone, and food. If you had a car payment of $400 and student loan payments totaling $250, then in this example your ratios would be $1,400 _ $400 _ $250 _ $2,050. Divide that by your gross income of $5,000 and your back ratio is .41, or 41 percent. Your overall ratios would be 28/41.