If you haven’t refinanced your mortgage in the last year, now is the time.
What is total debt service?
Total debt service is the percentage of a consumer’s gross annual income that is needed to pay all of his or her loans and obligations. It is a metric used a lot by mortgage lenders to determine borrowers’ risk level.
When mortgage lenders look at total debt service, they want to know how much of a loan applicant’s income would go toward their housing costs. This includes the borrower’s monthly mortgage payment, including principal and interest, property taxes, secondary mortgages and other housing expenses, such as HOA fees if they live in a condominium or other community run by a homeowners association.
Lenders figure the total debt-service ratio by adding up a borrower’s housing expenses and calculating what percentage that is of his gross annual income. The lender uses that percentage to gauge risk. A borrower who spends 60 percent of his income on housing debt will be considered a much higher risk to miss payments or default than a borrower whose total debt-service ratio is only 20 percent.
Of course, debt-service ratio is just one factor mortgage lenders consider when they determine risk level.
Total debt service example
Abby applies for a mortgage on a $250,000 house. She makes a down payment of 20 percent, or $50,000, which means she needs a mortgage for $200,000. With a 30-year fixed-rate loan at 4.25 percent, her monthly principal and interest payment would come to about $984. Add to that $1,900 a year in property taxes and $3,000 a year for home insurance. Abby’s monthly housing debt would run her about $1,392 a month, or $16,704 a year.
Her gross annual income is $80,000 and she has no other debts. Abby’s lender calculates her total debt-service ratio:
$16,704/$80,000 = 20.8 percent
The bank gives Abby a mortgage because her housing debt will be less than 21 percent of her gross income, well below what the bank considers risky. Abby also has other factors in her favor, such as a solid credit history and credit score.
Use Bankrate’s calculator to figure out how much house you can afford to buy.