This is a common term used when determining how much you can afford to spend on purchasing a home. Calculating your debt to income ratio is the first step in analyzing your buying power. Once you have that ratio, you can then compare the cost of a home and if it falls within your debt to income ratio.
The debt-to-income ratio is the way mortgage lenders decide how much money you can afford to borrow. It is the percentage of your monthly gross income used to pay your monthly debts (not monthly living expenses). Two calculations are involved, a front ratio and a back ratio, written in ratio form, i.e., 33/38.
The first number indicates the percentage of your monthly gross income used to pay housing costs, such as principal, interest, taxes, insurance, mortgage insurance and homeowners’ association dues. The second number indicates your monthly consumer debt, such as car payments, credit card debt, installment loans, etc.
So a debt-to-income ratio of 33/38 means that 33 percent of your monthly gross income is used to pay your monthly housing costs, and 5 percent of your monthly gross income is used to pay your consumer debt—so your housing costs plus your consumer debt equals 38 percent.
33/38 is a common guideline for debt-to-income ratios. Depending on your down payment and credit score, the guidelines can be looser or tighter, and guidelines also vary according to program. The FHA, for instance, requires no better than a 29/41 qualifying ratio, while the VA guidelines require no front ratio but a back ratio of 41.