Rent to Own Budgeting
One of the very first steps before contacting rent to own house sellers is to calculate your budget for the monthly rent payment as well as a suitable house payment after the lease. As the buyer whom is in line to purchase the house at the end of the lease contract it is assumed you will have the funds to do so.
The Debt-to-Income ratio is a commonly used formula to calculate your affordable monthly payment and is also used by mortgage lenders to see the maximum loan you can qualify for at the end of the lease. Also known as DTI, the Debt-to-Income ratio is the building block of finding the correct house to rent to own, as it shows the amount of DTI you have as a buyer. The DTI has two parts, the front ratio and the back ratio which will be explained below.
Front Ratio
The front ratio is the percent of income that lenders use to find a comfortable monthly amount the buyer can afford to pay for housing costs. The housing costs can include the principle and interest on the home loan, plus taxes and insurance. These four financial elements, also known as PITI, are the basic obligations a buyer must meet for the rent to own home purchase.
Typically, the front ratio mortgage lenders allow 28% of a buyer's gross income (earned income before income taxes are deducted) to cover PITI. Loans issued under the FHA (U.S. Federal Housing Authority) are allowed slightly higher amount at 31%.
Back Ratio
The back ratio includes the obligations calculated in the front ratio and adds other types of ongoing debt the buyer may need to budget for during the lease and after the purchase. This can include items such as credit card payments, car payments, student loan payments, alimony, child support, etc. The ratio is 36% for regular lenders or 43% for FHA lenders. So this means, lenders will like to see buyers paying no more than between 36% and 43% of their gross income toward ongoing debt or longer term financial obligations. Of course the buyer will have other expenses to think about that are not included, like groceries, utility bills or other unexpected expenses.
Calculating the DTI
The first step to achieving the DTI is to find the buyer's gross monthly income. To do this, divide the yearly income (before taxes are taken out) by twelve months. For example, the buyer has a gross annual income of $75,000 which is divided by 12 months to get a gross monthly income of $6,250. This gross monthly income will be used when computing the front and back ratios.
Front Ratio:
Standard Lender: ($6,250 gross monthly income) * (.28) = $1,750
FHA Lender: ($6,250 gross monthly income) * (.31) = $1937.50
Back Ratio:
Standard Lender: ($6.250 gross monthly income) * (.36) = $2,250
FHA Lender: ($6,250 gross monthly income) * (.43) = $2,687.50
In conclusion, the results of the DTI calculations state a buyer whom earns $75,000 gross annual income can qualify for, and afford, a monthly house loan payment of $1,750 for a standard loan, or $1,937.50 for a FHA loan to cover the PITI (mortgage plus property tax and insurance). The results also say the buyer can afford a total monthly debt level of $500 dollars more (to cover car loans, credit card payments, etc) for a standard lender or $750 more for an FHA lender. These numbers were found by subtracting the front ratio from the back ratios for both the standard lender and the FHA lender.
In conclusion, to calculate the buyer's DTI monthly maximum, a buyer needs to take their annual gross earnings amount (before taxes and deductions), divide by 12 (to calculate monthly gross income). Then multiply that gross monthly income just calculated by .28 for a standard front ratio DTI, and .36 for a standard back ratio DTI amount. Simply take the same gross monthly income and multiply by .36 and .43 for FHA front and back ratios.