Get to Know Your Debt to Income Ratio

2 min to read

141572559When preparing to enter into the process of buying a home, it is important to fully understand your financial life.  If you feel comfortable, and are ready to take on a new home purchase, it’s important to be proactive, set goals, and follow through so that homeownership dream can become a reality.

A great place to start is by considering your debt to income ratio.  A debt to income ratio compares your monthly payment obligations to your monthly gross income.  Really, it is simply the percentage of your income (before tax) that you have to spend monthly.  For example, what percentage of your income is paid for rent, student loans, car payments, or insurance?  Compare these monthly payments to your income to get an idea of your debt to income ratio.

In addition to being a good tool to estimate your financial situation, lenders use the debt to income ratio to determine the terms of a loan.  If total monthly payments (including those on a home) are greater than 43% of income, most normal lenders will not typically extend credit to a borrower – or will do so at a very high interest rate.  In order to secure a loan, or to get a reasonable interest rate, make sure you aren’t taking on too much debt at one time.

If it seems like your current debt to income ratio exceeds 43%, consider taking steps to lower the ratio before your purchase a home.  Some common ways to lower the debt to income ratio are:

-Take on greater monthly payments to pay off existing debt

-Avoid taking on new debt until old debt is further paid

-Cut spending wherever you can

-Use your resources efficiently (energy, TV and internet, car, cell phone data, etc.)

You should recalculate your debt to income ratio monthly to check your progress, and adjust your financial activity as necessary.

Another debt to income ratio used by lenders and prospective buyers is called the housing ratio, which is the percentage of your gross monthly income that you spend on housing.  In the case of a renter, your financial obligations are rent, utilities, and anything else collected by your landlord to pay for your housing.  When thinking about mortgage payments, the suggested percentage of income you should spend on monthly housing expenses (mortgage payments) should not exceed 28% of income

Keep the debt to income ratios in mind to help yourself lock down a great loan rate and to help make sure you are able to afford the cost of living while you finance your home.