25% Gross Income. Don’t become a Jones!

When we set out on our home search we often think of a lot of things but rarely do we really analyze our budget totally. For many years Conventional Lending and Conventional Wisdom would tell you that your Housing payment Taxes and Insurance should not exceed 28%. Government Lending would set that standard over the years at 31%.

What do the Experts Say? In the book Total Money Makeover by Dave Ramsey he suggests that 25% is a great number to shoot for.

So what do these percentages mean? Debt to income is a measure of your debt versus your income. In this case the debt that we are talking about is your total housing responsibility. The income is your Gross Monthly Income not what you take home to live on.

Let’s Look at Example – Borrower A makes $8,000 per month Gross Income. Their Future Housing Payment will be $2,700 out the door. Their Debt to income in this case would be 2700/8000 = 34%. Based on conventional wisdom or even the number for government lending this would be higher than we would like to see. However, it is very common that this is acceptable through the automated underwriting engines. In fact I have seen ratios that are in the high 30′s and low 40′s make it through the system. In this example it would be advisable to have a payment that does not exceed $2500 on the government side and $2240 on the traditional conventional thought. According to Dave Ramsey $2,000 would be the max and I tend to agree with him.However, if I insisted on this I would be out of business!

Why are high ratios bad? Just take a look at the numbers as a whole. Going back to Borrower A. Borrower A represents a family of five. They like most families have expenses like daycare, food, insurance, cell phones, and you know the rest. So let’s mock an expense report.

Gross Monthly Income $8000 in a 30 % tax Bracket leaves the take home pay at $5600 per month.

$5,600 – $2,700 Housing – $800 Food – $500 in Auto Loans – $800 in Daycare conservatively = $800 remaining for all the everyday life expenses. It would be impossible to not use a credit card. How could you save for retirement, Christmas, incidentals etc.

Same Example: $5,600 – $2,000 Housing – $2,100 = $1500 which would be better.

So why do we not all buy with a 25% housing ratio? The Jones’. We get so caught up in the need to have a home like our friends. Facing the fact that we simply may not be able to afford a home is just to difficult. We, as a society, have not been taught about the numbers. I realize that some wise individual may read this and say you did not mention the tax benefits of home ownership. You are making a lot of assumptions on net income as they have three dependents, 2106 expenses, and a whole slough of write-offs. I understand that. I also know that I did not include many of the incidentals that we come across or even mention vacation. I simply want to illustrate a point that may get us to challenge ourselves to look deep into our finances. Owning a home is awesome. Living to service the home is not. When you are stressed each month about whether or not you will be able to pay by the first your whole life is affected.

Please consider your entire budget and consult a CPA before you even look at homes – The reason that I say this is simple. If I go to the local lots and test drive a 2010 Range Rover and then I realize that to have a life I would have to buy a base model pickup truck disappointment would overtake me.

My Job as your professional consultant for Mortgage is to lay out the facts – I want to make certain that I set you up for financial success not only a mortgage. I wish that I had been set down and taught these very basic principles before I entered the work world and housing market.

The principles out-lined here are not my own. They are a collaboration of wisdom that has been passed on to me over time and through trial and error.They are opinion. I have seen some great devastation and continue to see situations that are less than ideal and always will. Free will is awesome we are all given the opportunity to decide what is right and wrong for ourselves. I hope that you have enjoyed the material.

Definitons: DTI also known as debt to income

DTI also known as debt to income is becoming one of the most important factors when obtaining a loan. The debt to income is a ratio of your debt versus the gross monthly income. This ratio is largely evaluated when determining the risk of the loan. Here is how we calculate your debt to income.

Front end debt to income is the total housing expense divided by your gross monthly income. Total housing expense includes your principle and interest, mortgage insurance, taxes and homeowners insurance monthly. This is commonly referred to as PITI, principle, interest, taxes and insurance. The mortgage insurance is not always charged.

Ex. (excludes mortgage insurance) 100K loan amount @ 6% interest = $599.55 principle and interest + $104.17 taxes and $30 for homeowners insurance = $733.72. If you make $3,000 per month gross then your front end DTI will be $733.72/$3000 = 24% housing debt. This means that your housing debt monthly is 24% of your gross monthly.

The back end ratio which is very closely looked at will take into account the minimum monthly debts that you are expected to pay that report to your credit. Examples include credit card minimums, car payments, student loans, or any other note loan. So the back end ratio will be the housing expense + all the minimum amounts due divided by your gross monthly.

Ex. car payment = $300, credit cards = $300 and student loan = $200 then you have $800 debt load per month. If the house payment is $733.72 + $800 = $1533.72 divided by the gross monthly income of $3000 will give you the back end ratio of 51%.

51% back end ratio would be considered very high and you would have to have compensating factors.

When evaluating your own debt to income simply remember the new total housing payment + other debts that are required to be paid on the credit divided by your gross monthly income should give you an idea. The recommendations for an FHA loan are 31/43 which would include the additional payment of mortgage insurance. Dave Ramsey in his book The Total Money Makeover recommends that your housing payment or front end ratio should never exceed 25%.