The next thing an underwriter will examine is how much money you earn and how much you owe. From this information, income-to-debt ratios are created that become benchmarks for deciding what type of loan you can afford.
The traditional ratios were 25%–35%. This meant that the most your mortgage payment should be was 25% of your gross (total) income. If your salary was $4,000 per month, you should pay no more than $1,000 per month for your mortgage payment, which included principal, interest, property taxes, and insurance (PITI). This ratio of income to PITI is called the top ratio.
You were then allowed an additional 10% of your income to pay for other debts, like a car loan. Your monthly payments for all debts, including your mortgage, could not exceed 35% of your gross income. This is called the bottom ratio. If your ratios exceeded these numbers, you would have to seek a loan from a high-risk lender and pay higher interest and fees.
While the income-to-debt ratios allowed became a higher percentage of your gross income over time, because of the recent problems with loan defaults, lenders are now adhering to more traditional guidelines. The days of lending to borrowers based on unrealistically high ratios are over, at least for the foreseeable future.
Another variation is a high mortgage ratio and a low overall or total debt ratio. If you are going to pay 30% of your income for your mortgage expenses but have no other debt, you are above one ratio but below the other. Your lender’s policy and your credit score will be the determining factors in whether or not you will qualify for a mortgage.
In most instances, the policy of the individual lender will determine the ratio allowed. You can simply ask a prospective lender the numbers it uses to give its most favorable interest rate.