Knowing how to calculate your debt-to-income ratio is an important part of the home-buying process.
Once you've made the decision to buy a home, you’ll start the exciting process of searching for that perfect house. This is part detective work and part treasure hunt. After all, every home buyer is different and with so many houses out there to purchase, finding the one to match your budget and match your tastes can be quite an adventure.
One of the first things you need to do is figure out your budget, and one of the main factors that determines your budget is the size of the loan you can get approved for.
The importance of your debt-to-income ratio
Many lenders who are deciding on the type, size and interest rate of the loan to offer you will take a close look at your debt-to-income ratio. Basically, this is the amount of reoccurring debt you have relative to your monthly income.
Ideally, this number should be low. When lenders see a lower number, it’s evidence that you will have more available income to pay your monthly mortgage, hence the more money they’re willing to lend.
If you keep your debt-to-income rate below 36 percent, you’ll be in good standing.
An easy calculation
How do you arrive at this ratio? The calculation is actually quite simple. Take your total reoccurring (monthly) debt and divide it by your gross monthly income.
For instance, let’s say you have $1,000 in reoccurring monthly payments and earn $4,000 each month. Simply divide 1,000 by 4,000 and you will get .25, or 25 percent.
The total monthly debt obligations should include, but are not limited to:
Understanding your debt-to-income ratio is an important first step on the house-buying journey. Determining your ratio can help you to craft a financial strategy for how to proceed to get you into the home of your dreams.