Debt service is the principal and interest you owe on a loan over a set period, usually stated by the month or the year. A $300,000 mortgage at a 5.75% rate on a 30-year fixed carries $1,750.72 of monthly debt service, which adds up to $21,008.64 a year. Every loan you have carries its own debt service, including a car loan, a personal loan and a student loan.
Debt service and the full house payment
The interest part pays the lender for the money, and the principal part shrinks the balance. Early in a 30-year loan, most of each payment is interest. The principal share grows a little every month, a schedule called amortization.
Property taxes, homeowners insurance, mortgage insurance and HOA dues usually ride in the same monthly mortgage payment. They're costs of owning the home, and they aren't repayment of the loan, so they sit outside debt service. Lenders still count every one of them when they size your house payment, known as PITI.
How lenders use it
For a home you'll live in, the lender adds your full house payment to the monthly payment on each of your other debts and divides by gross monthly income. That's your debt-to-income ratio. FHA allows total debts up to 56.9% of income with an automated approval, and Conventional allows up to 50%.
On a rental bought as an investment, lenders often look at a different number: the debt service coverage ratio, which compares the rent with the full monthly payment. It has its own dictionary entry and its own calculator.
A worked example on $6,500 a month
A buyer earning $6,500 a month gross buys a $320,000 single-family home with FHA at 3.5% down. The $308,800 base loan becomes $314,204 with the 1.75% upfront premium financed. The buyer also has a $380 car payment and a documented $150 student loan payment.
| Piece | Monthly |
|---|---|
| Mortgage principal and interest at a 5.75% rate | $1,833.61 |
| Car loan | $380.00 |
| Student loan | $150.00 |
| Total debt service | $2,363.61 |
| FHA mortgage insurance (0.55% of the base loan ÷ 12) | $141.53 |
| Property taxes (0.95% of the price ÷ 12) | $253.33 |
| Homeowners insurance | $283.00 |
| Total counted in the debt-to-income ratio | $3,041.47 |
A year of debt service comes to $28,363.32 ($2,363.61 × 12). In the first mortgage payment, $1,505.56 is interest ($314,204 × 5.75% ÷ 12) and $328.05 goes to principal. The total ratio is 46.8% ($3,041.47 ÷ $6,500), well inside FHA's 56.9% limit.
Lowering your debt service
- Pay off a small loan before you apply. Clearing the $380 car payment frees room for about $65,000 more mortgage at a 5.75% rate.
- Borrow less. Each $10,000 less borrowed cuts principal and interest by $58.36 a month at a 5.75% rate.
- Buy down the rate. Discount points paid at closing lower the interest in every payment.
- Hold off on new loans until after closing, since each new payment adds to your debt service.
The mortgage payment calculator splits any payment into principal, interest, taxes and insurance, and the DTI calculator shows how each debt moves your ratio. To see which debts are worth paying off before you buy, call AAA Capital Funding at 888-601-8344.