Owning a home is one of the more effective ways to achieve financial security. After all, you can probably expect your house to appreciate in value over time, allowing you to borrow against its equity. You may also be able to sell the house in the future for a large profit.
If you want to secure financing to buy a home, you need to know your debt-to-income ratio. This ratio, which mortgage lenders routinely consider, compares your outstanding debt to your gross monthly income.
Your relevant debt and income
Your groceries, utilities and other everyday expenses are not likely to have an effect on your debt-to-income ratio. Still, when calculating your ratio, you must include the following:
- Monthly rent or mortgage payments
- Monthly child support and alimony payments
- Monthly student and auto loan payments
- Monthly credit card and line of credit payments
Once you have added together all your relevant debt, you can determine your debt-to-income ratio by dividing by your gross monthly income. This amount, which probably appears on your regular paystubs, is simply how much money you earn each month before your employer takes deductions.
The magic number
Your ability to secure a mortgage may depend on a variety of factors. Still, the U.S. Consumer Financial Protection Bureau recommends keeping your debt-to-income ratio below 43%. If your ratio is higher, you may struggle to obtain financing for your new home purchase.
Regularly calculating your debt-to-income ratio is one way to improve your creditworthiness. Ultimately, if you believe your ratio is too high, it is imperative to have a clear grasp of your debt relief options.