Debt-To-Income Ratios Will be A Huge Factor In Determining How Much House You Can Afford

Banks have really screwed things up this time. Over the past 10 years, poor underwriting controls basically gave anyone with a pulse a loan. Banks have been known to throw caution to the wind when making money comes easy in a booming real estate market. In a seller's market, foreclosures are almost unheard of because home values grow so rapidly that a profit in selling is almost guaranteed. This is how the house of cards is built before reality comes in the form of a hurricane and unleashes it's furry on all that were irresponsible with their finances.

Improper lending standards have caused so much damage to the lending industry that lenders are now forced to change the way they do business. The great gatekeeper of prudent underwriting was the Debt-To-Income Ratio. This was used by lenders to keep the borrower from getting into financial turmoil. Unfortunately, this formula was altered to such an extent, that it no longer served it's original purpose.

Debt-to-income ratios are making a comeback and in a big way. There are 2 types of debt-to-income ratios. The first is the Standard or Front-End debt-to-income ratio which measures as a percentage, all of the costs associated with your monthly mortgage payment (principle, interest, property tax, homeowners insurance, PMI, etc...) against your monthly gross income. Your monthly mortgage payment should not exceed 28% of your monthly gross income.

The second type of ratio is the Total or Rear-End debt-to-income ratio. This is expressed as a percentage as well and includes all of your yearly debt (mortgage, car note, credit cards, alimony, student loans, etc...) against your yearly gross income. Your total yearly debt should not exceed 36% of your yearly gross income.

In figuring out how much house you can afford, use the ratios I've given above to give you a realistic idea of what today's lenders will approve. This is the method lenders should have chosen when making loans through the housing boom but they chose not to. Greed and a need to compete blindly with other lenders caused the deterioration of ratios and their usefulness in protecting not only the borrowers but the lenders and banks themselves. Debt-to-income ratios will be used as a main underwriting tool for current and future lending. This will translate into less house being purchased as a percentage of available income which will in effect keep more homeowners in their home and out of financial ruin. Isn't that the way it should be?