Buying? Know Your Debt-to-income Ratio

Blog Post Image
Financing

Once you’re ready to make the big move, and you start looking for the home you’ve always dreamed of,  you’ll hear a lot of mortgage jargon that you may be unfamiliar with. One such term you’ll hear is “debt-to-income ratio”, and unless you’re a math wiz, this can sound intimidating. Debt-to-income ratios are actually simple to understand, and helps you understand how much you can afford before you start looking for a home.

Your debt-to-income ratio is the way your mortgage broker decides how much of a home payment you can afford. It is the percentage of your monthly gross income (before taxes are deducted). Two calculations are involved: the front ratio and the back ratio, written in ratio form, i.e., 33/38.

What do the numbers mean?

The first number in the ratio indicates the percentage of your monthly gross income used to pay your housing costs. Your principal, interest, taxes, insurance, mortgage insurance and association dues are all considered with this number. The second number is your other monthly debt, like you car payments, credit cards, installment loans, etc. Other living expenses like utilities are not considered to be debt.

2debt-to-income-blog


If you have a debt-to-income ratio of 33/38, that means that 33% of your monthly gross income is used to pay housing costs, and 5% of your monthly gross income is used to pay your other consumer debt, therefore your housing costs plus your consumer debt equals 38%.

33/38 is the guideline that many lenders use for debt-to-income ratios. Depending on how much you put down and what your credit score is, these guidelines may be looser or tighter, and guidelines can also vary based on each program. The FHA requires a 29/41 qualifying

Your debt-to-income ratio affects your ability to purchase a home, and your other purchases as well. Debt-to-income ratios are excellent indicators of a consumer’s creditworthiness and overall financial health. You should always know your ratio, and keep it as low as possible. Your consumer-debt number should never go higher than 20%.

If you it rises above 20%, you may:

•  Compromise your ability to make other big purchases like cars, major appliances, etc. 
•  Pay higher interest rates and get not so great credit terms when buying a home or car.
•  Have a difficult time getting additional credit.

Remember to calculate your debt-to-income ratio before you begin your home search. It’s a good idea to get your credit in line so you can get the best terms, the lowest interest rate and the most house possible. If you need help with this, please contact me!

 

cta-2