Calculating The Debt Portion Of The Debt To Income Ratio

• Introduction
• The Debt to Income Equation
• Best Case Scenario for maximum debt to income by loan type
• What counts as debt and what doesn’t count as debt
• How to figure out the 5 inputs of your house payment
• Student loan calculations
• A little bit about collections
• Conclusion

Introduction

We’ve been talking for the last couple month or so about how to buy a house, and this will be the first of a two part post before we leave that subject for a while.  If you want to know if you are ready to buy a house click here, the steps to buy a house click here, how much money you will need to put down click here, how much money closing costs will take click here, if your credit is good enough (and if not how to improve it so it will be) click here, and what you need to know about the house itself for the house to qualify for a loan click here. Today, we will be answering the question of “Can I afford to buy a house?” aka, what’s your capacity for debt, aka… the dreaded debt to income ratio.

Can I afford this house?  The debt to income question.

The formula to figure out your debt to income ratio is to add up all of your monthly payments for financed debt (things like vehicles, boats, credit cards, student loans, child support or alimony obligations) and add in the full value of what you are paying for your house (your principal, interest, taxes, insurance and home owners association dues) to get your numerator (for the math challenged that’s the number on the top of the fraction), and then add up all the income of all the co-borrowers to get the denominator (that’s the bottom number on the fraction).  Once you get those two numbers in your fraction you convert that number to a decimal (It should be somewhere between 0 & 1) and go from there.

Ok- I know you guys who have been with me from the beginning are going to be shocked to hear this, but every deal is totally and completely specific and different underwriters can look at the same paystubs, Taxes, W2’s and credit reports and come up with a different number.  Also, based upon other factors in your specific credit situation this can impact what is an acceptable debt to income ratio.

Generally, the best case scenarios for highest allowable debt to income ratios for loans are as follows:

• FHA- .559999999
• VA- .56 or .57 (But I did once get an approval for a guy with a 67% dti- but that was seriously unexpected)
• Conventional- .4999999
• Affordable program- .45 or .46, but sometimes up to .499999
• USDA- same as affordable- somewhere between .45 and .50
• Jumbo- .42 or .43 as a general rule (these are more case specific than any other deal though)
• Construction/Land- .43 or so
• Hard Money- debt to income ratio?  What debt to income ratio?  How much cash you got bro?

Calculating The Debt in the Debt to Income Ratio

As mentioned above, to calculate the debt we add up all your bills and obligations to find the numerator.   Every bill is treated a little differently though, but generally monthly payments are used to calculate this number.

What doesn’t count:  Utility bills like gas, electric and water; Cell phone bills; health insurance premiums; employment taxes; food; gas; car insurance; life insurance; anything else.

What does count:  Any kind of car loan; credit card minimum payment; most student loans (this is complicated- we will have a separate part of this post discussing these in a minute); installment loans; Child Support; imputed payments for collections (this is also complicated- we will discuss this in a minute as well.

Added to these bills are potentially 5 different inputs for figuring out your house payment that will be unique to your individual house:

1. Principal & Interest- (Loan amount amortized based upon interest rate and term- this doesn’t vary by house, merely rate, term and amount borrowed).
2. Real Estate Taxes- This varies by house- basically you multiply the tax rate by the appraised value, unless there is something wonky in the house you are buying, in which case. Not every $200,000 house will have the same tax amount.
3. Insurance- This too varies by house, based upon location, value of house, loan amount, condition of house you will get a different insurance figure- not every $200,000.00 house to use a median figure has the same insurance price.
4. Home Owners Association:  In Texas we have many different HOA’s. They aren’t a part of your mortgage payment (you generally pay this one time at the beginning of the year) but they are used to calculate your ratio.

OK- I said 5 inputs for figuring house payment and there’s 4 bullet points, but I lumped principal and interest into 1- so that’s 5 inputs- promise.

Special Circumstance Debts- Student Loans and Collections

Student Loans:

How the heck does my student loan debt get calculated? I’m in deferment. I’m income sensitive on my repayment.  What- Nobody told me I’m supposed to pay back that $187,000 that someone loaned me when I was young and dumb and 18…  Well, it varies by loan type and it’s complicated, but here goes my chance to try to explain all this without making your head spin (too much)

• Va Loan- We don’t count student loan debt on VA loans if it’s in deferment that will last more than 12 months.  If the deferment will be over in less than 12 months we take the greater of: A) Payment reported on the credit report; or B) Threshold payment calculation which is the total balance of the student loan, multiplied by .05 and then divided by 12.  So, if you owe $100,000 in student loan debt (I feel for you, I once owed this much) you would multiply by .05 and get $5,000, and then divide by 12 and get $483 or so as a minimum threshold payment.  So, if your credit report says you owe $500 a month then we use $500 to calculate the student loan debt for this loan, but if your payment was, instead, $450 then we’d use $483 as the minimum threshold payment.

I started with VA because they allow you to ignore student loans in deferment for over 12 months- everyone else does not extend this courtesy to borrowers in deferment.

• USDA Loan-  Use the greater of the fixed payment as reflected on the credit report or 1% of the total student loan debt. If you are in anything other than a fully amortized payment plan then we will default automatically to 1% of the student loan balance.
• FHA- Generally, we would use the greater of 1% of the total student loan balance or payment on the credit report.  However, if your payment on the credit report is less than 1% of the total indebtedness, and that payment is fully amortized, than you may use the payment on the credit report.  But, you are going to have to have some documentation if you are going this route.
• Conventional (Fannie):  We get to use the amount of the student loan payment on the credit report. Sounds simple, right?  Well, maybe, but if you are on an income-driven payment plan or deferral or forbearance it gets way more complicated
• Conventional (Freddie):  For loans in repayment we would use the greater of 0.5% of the total indebtedness or the actual monthly payment on the credit report.  Like a Fannie though, if you are in forbearance or deferment we use different and more complex calculations to get to your payment.

It’s here that I take a moment to note- hey- I’m here to help. Call me at 832-557-1095 with your specific situation. Or email me at gabekmg@gmail.com. I will walk you through it and do the math for you- I promise.

 

Collections:

Ok, I’m going to cheat here and not give you the entire story, because it’s long, differs by loan scenario, and it’s probably going to be the subject of a later blog. Some general thoughts:

1. Bad medical debt is almost never counted in your debt to income ratio
2. Charge offs are generally not counted in your debt to income ratio
3. Small collection amounts (added all together) generally don’t hurt you. In FHA, for example, if your total non-medical collections are less than $2,000 in total it probably isn’t counting
4. You might have to pay off a collection because the underwriter says so. You might have to pay one off to help your debt to income ratio to qualify.  
5. Even if the collection “doesn’t count” in the sense of it not hurting your debt to income calculation it’s still affecting your loan because it’s affecting your credit score

Some loans don’t count collections at all. Some impute a payment of say 5% of the total collection debt.  Some just are going to require that collection to go away at closing.  Again, this is very specific.  We will cover this in a later blog post with a fuller treatment of collections.

How do I improve my debt to income ratio on the debt side?

Whenever I get ready to do something difficult that takes a lot of work my thoughts drift to the greatest boxer of all time in training… The Italian Stallion, Rocky Balboa:

So, you sometimes have to get crazy.  Get the eye of the Tiger.  But seriously, don’t try this at home on your own, call me and I will help you come up with the least painful plan to improve your debt to income ratio on the debt side. We can’t all be Rocky. Sometimes we want to hit the easy button.

 Conclusion:

Nothing about buying a home is intuitive or easy.  Calculating debt in a debt to income ratio is something that reasonable minds, even in the field, will often disagree about or struggle with.  It’s really hard to do it on your own. Let me be your easy button and help walk you through this process, let you know what your debt to income ratio is, and let you know the easiest way to improve that ratio.  Call me at 832-557-1095 or email me at gabekmg@gmail.com for a free consultation.  Until next week when we tackle the income side of the debt to income ratio.