Applying For A Mortgage? Understand Your Debt To Income Ratio
When you are finally considering purchasing your own home there is a lot you need to do to understand your finances so you can get a mortgage that works for your life. One of those key numbers is your debt to income ratio.
To understand what you can afford you first need to be familiar with two numbers: the income you take home every month or year and the amount of debt payments you are making in that timeframe.
Debt payments are any money paid back to an already borrowed amount. Think a car payment, payments on your student loans or monthly payments on your credit card balances. If you are repaying then that is a debt payment.
How To Calculate
You can calculate your number by taking the minimum required payment for all of your outstanding balances and dividing them by your gross monthly income before taxes.
So the total of your minimum monthly debt payments is $525 and you take home a gross of $4,000 before taxes you divide $525 by $4,000 and multiply it by 100 to get 13.12%. That percentage is your debt to income ratio.
How Do I Know If It's Good?
Generally the lower the ratio the better shape you are in financially. A low percentage means you have less debt and more available income to spare for a new mortgage, making you a more trustworthy borrower.
To get a qualified mortgage your ratio has to be below 43% but generally lenders like to see a ratio below 36% - but it varies from lender to lender.
How Do I Improve Mine?
If you have a high debt to income ratio your best bet is to delay applying for a mortgage until you can lower it. That will enable you to get a better rate and show lenders you are a more reliable borrower.
Lowering your ratio is simple - either have less debt or have more income.
If you are seriously looking into buying a home you might want to take a few months and really focus on paying down some of your debts, not just making minimum payments. Paying down your debts will in turn lower your monthly minimums making your ratio decrease.
You can always get a second job or ask for a raise but making a concentrated effort to pay down debts and be frugal for a while might actually be a behavior that will stick in the long run.
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