The debt-to-income ratio, which is expressed as a percentage, is one of the most important numbers banks examine when deciding how large a loan to extend to you. As the number increases, banks’ assessment of your credit risk also rises.
It is seemingly a straightforward calculation. But, it is decidedly more complicated, particularly in New York City. Nonetheless, it is essential to get a handle on the number so that you can understand your housing budget.
What is debt-to-income?
Lenders break out the debt-to-income ratio further into front-end and back-end ratios. Typically, the ratio uses your monthly debt payments and income. Therefore, the denominator is your monthly income. The bank calculates the ratios based on your gross monthly income or before your employer takes out any payroll or other deductions. It also includes other income, such as interest.
The numerator depends on whether you are calculating the front-end or back-end ratio. A bank’s front-end ratio adds your housing expenses. This includes your monthly mortgage payment, taxes, homeowner’s insurance, and maintenance fees/common charges. The back-end ratio is more extensive. This is everything the front-end ratio includes plus your other monthly debt. So, monthly payments for items such as student loans, car loans, credit cards, and alimony are also added. Payments for items such as utilities, food, and healthcare are not part of the calculation.
However, while you and your lenders know your existing debt payments, this is not the case for your housing expenses, which are estimated. This is not as challenging as it appears, though. You can use any free online mortgage calculator to figure out your mortgage payment, including principal, interest, taxes, and insurance. Generally, homeowner’s insurance is $1,000 to $2,000 per year, and you can figure the property taxes based on several buildings that you are interested in. You can do the same thing for maintenance fees or common charges.
Strict New York City co-op boards
Many New York City lenders are looking for a back-end ratio that does not exceed 43%, although traditionally it had been 36%. This allows you to qualify for a conforming mortgage. Early in the home buying process, you should ask various lenders what about its requirements. If your ratio exceeds what lenders allow, you may need to rethink your housing budget. You can also take steps to lower your ratio, such as repaying debt. It is advisable to formulate a budget to help you achieve your goal.
However, in New York City, co-op boards may require a lower ratio. In some instances, they will not approve your application if your ratio is greater than 25% to 30%. The more conservative approach is designed to protect the building’s financial interests. Condo boards are less strict.
A mortgage lender
After you have done your calculation, it is advisable to work with a lender. He or she can pre-approve your loan, which also helps support your bid. Remember, this is the maximum amount you can borrow, but you need to feel comfortable with your mortgage loan. Also, your agent can tell you what a building’s co-op board acceptable debt-to-income is to ensure you are within the range.