Learn how to calculate your debt-to-income ratio

Dear Ms. Mortgage Maven,I make $33,000 per year and want to buy my first home. I had some questions about lowering my debt-to-income ratio. My sister wants to take over my car and the payments of $550 a month. The car company told her they could put the payments in her name, but I would still be on the note, like a co-signer. Would that debt still count against my total debt-to-income ratio, even if we sign an agreement that she now owns the car?I cannot sell the car to her outright because it is worth less than what I owe on it, since I rolled over the unpaid balance from my last car to this car. Let me know what your thoughts are on the situation.

Lateasha

Dear Lateasha,

You clearly have done some research into the home buying process. Not too many people even know what a debt-to-income ratio is, and even fewer are concerned about manipulating their own debt-to-income ratio.

I cannot tell you how many times I have spoken with would-be buyers who have steady jobs with a modest income and have a car payment that is proportionally out of whack for their income. You make $33,000 per year, and your car payment is $6,516. That's about one-fifth of your income. Ouch!

Debt-to-income ratios are just that - the relationship between your debts and your income. Lenders calculate a borrower's monthly debt-to-income ratio. Simply put, we take your monthly income ($33,000 divided by 12 = $2,750/month). Then we tally up all the minimum monthly payments required by the bills that show up on your credit report - student loans, car payments and credit card bills are the most common.

Let's say your monthly payments on your student loan are $100, your credit card payment is $50 and your car payment is $550. Your total bills are $700 per month. With a salary of $2,750/month, your debt-to-income ratio is just above 25%. Why is that significant? Because various loan programs from different lenders will allow for a debt-to-income ratios of generally 33% - 50% (and even higher), including your mortgage. With a "DTI" of 25% already, you do not have a lot of room left over for a home loan.

If your sister is added to the loan and you are a "co-signer," the debt will still be factored into your debt-to-income ratio. The debt and payment record will still be on your credit report. If she fails to pay on time, any negative information caused by your sister will be reflected on your credit report as well. If the loan remains in your name and if your sister makes the monthly payments on time for the next twelve months in a way that can be documented, then that monthly debt will no longer be factored in to your debt-to-income ratio.

If you do this, be sure to set up a reliable and verifiable system for her to make the payments to ensure that they are paid on time. If she is late with a payment, then guess whose credit score will be adversely affected - yours! You will have to monitor her payments every month, in advance of the due date, to ensure the loan is paid on time. You also would be wise to make sure you are able to pay it if she is unable to do so. I would also strongly advise you to talk to your car insurer if she is going to be the primary driver of your vehicle.

I often tell people that every dollar they spend on the car loan is a dollar less they can spend on a mortgage. You monthly car payment equates to about $85,000 in mortgage debt, at 6.5% interest. Having a record or your sister making twelve months of on time payments will increase your purchasing power and put you within reach of buying a modest home for yourself.

Your sister taking over the car payment frees up a tidy sum each month for you to save. I would suggest that you talk to your bank about having money automatically transferred into a separate savings account every pay period or month. The savings you accumulate will help you qualify for a home loan, either in the form of a down payment or as reserves. Best of luck,

Jessica White, also known as "Ms. Mortgage Maven," is a DC resident and a home loan consultant for the largest lender in the country. Please call or email her with your questions at 202-607-4449 or jessica@msmortgagemaven.com. You can also visit her online at www.msmortgagemaven.com.