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Dear Money101:

Can you give an explanation on debt to disposable income ratio (DDIR)?

-John

In a previous article, we talked about DTI, or your debt to income ratio: A divided by B, where A represents your monthly debt payments added together and B represents your monthly gross salary plus any other income or bonuses before tax. Divide A by B to calculate your DTI.

So how is DDIR different from your DTI? You don’t pay off your debt with pre-tax income. Your disposable income is defined as your income remaining after federal, state and local taxes.

Keep in mind that disposable income is different from discretionary income. Your discretionary income is your money after taxes and after your personal necessities. These necessities include transportation, groceries, housing expenses, childcare and other costs of living.

If your disposable income increases, your marginal propensity to consume goes up too. That means that when you’re paid more, you’re likely to spend more, as well. Let’s say you got a $100 bonus around the holidays; if you took that money and spent $70 of it, your MPC would be 0.7 (70/100).

Your debt to disposable income ratio – DDIR -- is an important factor in qualifying for a loan. If you are looking to get a mortgage loan, be prepared to face a tougher standard than that of a few years ago. John Deguenther, a mortgage broker with American Home Mortgages, said the bar has indeed been raised since the days when “everybody and their brother qualified, if you could breathe.

“We didn’t even run ratios. Now we’re back to the way we used to underwrite loans in the 80’s,” he said.

The reliance on ratios is not meant to be discriminatory, but rather to convince the bank that the loan will be paid. 

“We just don’t want to get people in over their heads in debt--therefore we look at the ratios,” said Deguenther. He said it ensures “that you have enough money left after taxes and living expenses to make sure that you can make the payment.”

Knowing the value of your disposable and discretionary incomes is crucial to your financial health.

“Before you can understand your debt and income picture, you must have a sense of where you stand financially,” said Debora Blume, assistant vice president of communications at Wells Fargo Home Mortgage. “Looking at your outstanding debt – credit cards, car payments, mortgage and student loans – can help you determine what your true needs are and the obligations you are managing.”

Your financial goals will definitely be important in the loan process, but your capability to follow through with your goals overrides wishful thinking. Make sure that you have your discretionary spending under control, especially if it can be used as equity for a mortgage.

“We don’t want more than 36% of your income going towards a house, [after] taxes and insurance along with all other obligations; car payments, credit card payments and that type of thing,” said Deguenther.

Here’s how to calculate your disposable income: Let’s say your gross income is $36,000 per year, your monthly gross income is therefore $3,000 per month. If you estimate that your federal income taxes are $500 per month, state taxes $250 per month, and Social Security and Medicaid deductions around $270 – add those up and then subtract the total from your monthly gross ($3,000), and your monthly disposable income comes to $1,980. In addition to this, some cities include income taxes which would decrease your disposable income further.

Continuing this example, to calculate your discretionary income, you would then subtract from $1,980 the total of monthly rent or mortgage payment, utilities, food, car payments, gas and maintenance, and other living costs.

Assume the following: rent is $600, utilities $200, food $400, car payments, gas and maintenance total $400, and your miscellaneous costs total at $100. From this example, your monthly expenses would be $1,700. (This example does not include credit card payments, health insurance, or what you put towards your 401K or savings account.) You have a discretionary income of $280 ($1980-$1700).

What this means is that you have $280 of available income to put towards whatever you deem is necessary: to save up for a new car, a down payment on a house, or additional savings.

Knowing both your disposable and discretionary income is a major component of being a financially responsible adult and planning for a successful financial future. It is a guide to both you and the lender. Whatever your individual numbers are, it is useful to know your DDIR in order to live within your means.

E-mail your questions to Money101@FOXBusiness.com, and let us take off some of the pressure.