Housing Debt Ratios
Defending Home Base

Housing debt ratios have been used for many years by mortgage lending institutions.

Prior to the banking world going off the rails in the 1990's using lending standards that made sense only to those with very political agendas in mind, mortgage lenders who were (emphasis on 'were") the most conservative lenders in the world used two simple formulas to determine whether or not a customers would be able to repay their loans over the next 20 to 30 years.

These housing debt ratio rules worked well for years and you should use them as your guideline.

The first formula calculated the actual mortgage debt as compared to gross income. The rule is that your total mortgage payment divided by your gross monthly income may not exceed 28%. This can be called your "home ownership ratio."

Looks pretty simple, but let's break it down to it parts.

A "mortgage payment" by definition for this rule includes principle, interest, real estate taxes, homeowners insurance, mortgage default insurance and condo fees if applicable. It also includes second mortgages. So, if your payment to your mortgage company does not contain all of above because you pay your condo fees or homeowners insurance, or have a second mortgage or home equity loan with another lender, you need to make adjustments to get a clear picture of your home ownership ratio.

Additionally, when you review your gross income (that is how much you make before federal, state, and local income taxes and any other deductions) you should only include guaranteed income. No overtime, bonuses etc.

Wow, that is strict! Yes, but using these guidelines very few people actually lost their homes to foreclosure.

The second part is also simple.

Take your "mortgage payment" and add to it all of your other outstanding debt payments…car loans, student loans, credit card payments, boat payments, etc., and divide that number by your gross monthly income. The answer should be 36% or less.

Move on to Consumer Debt from Housing Debt Ratios.

Back to Making a Budget.