Debt to Income Ratio - My Example June 8, 2006
Because of our recent move, I haven’t been able to post as much in the past few weeks. But I finanlly had some time to look at my housing costs and provide you a real world example of my debt to income ratio.
You know that debt to income ratio is a comparison of gross income to housing and non-housing expenses. According to the FHA, the monthly mortgage payment should be no more than 29% of monthly gross income (before taxes) and the mortgage payment combined with non-housing debts should not exceed 41% of income. (aka “29/41 qualifying ratio”)
Calculating the Debt to Income Ratio
To calculate your debt to income ratio first calculate your income before taxes. Next calculate your fixed debt payments like credit cards, auto loans, and school loans. Don’t include living expenses such as grocery, utility bills, or phone bills.
Example:
Gross monthly household income: $5,000
Fixed monthly expenses: $1,200
Debt-to-income ratio calculation:
$1,200 / $5,000 = 24.0%
Generally a ratio of 36% is considered high and creditors prefer people with lower ratios somewhere around 20%.
Here’s my ratio:
Old: 15%
New: 30%
We doubled our ratio, but because we no longer have any other debt, this ratio used to be approximately 25%. We felt that because of our age and financial ability, we made the move. At 30%, it’s on the higher end of the ratio, but our financial advisor thinks it’s ok. We don’t have any car payments, no gas to purchase, no school loans. Also, in NYC, it’s tough not to own property and be in the lower end of the debt to income ratio. For older people, it’s important to lower their debt to income ratio so that they can live a debt free life in their old age. Younger couples tend to have a higher ratio and probably should decrease this by 1% each year (more on this for a future post).
Comments»
[…] According to The Real Deal, New Yorkers are spending more than 30% of their income on housing, and in many cases, more than 50%. That doesn’t even include other debt as I mentioned in a previous article. By 2006, New Yorkers were spending more than 30 percent of their gross incomes on rent, surpassing what’s commonly cited as the maximum threshold households should spend on renting. The median share of income spent on rent by renters in the city rose from 28.6 percent in 2002 to 31.2 percent in 2005, according to a new report from New York University. Decreasing real income and increasing real rents were the main culprits for inching over the 30 percent threshold. … For unsubsidized, low-income renters in the city, the situation was even worse over the three-year period from 2002 through 2005. The median share of income spent on rent increased to more than 50 percent last year, up from the already dire 43.9 percent in 2002. […]
[…] I think I’m partially crazy for taking on a 30% debt-to-income ratio by buying a home in New York City. But if you read the NY Times article yesterday about people refinancing their mortgages before their adjustable-rate mortgages reset just to to keep their payments the same, I think it’s time to say that a lot of people are just delaying their debt drowning. […]