Over the next few weeks, we’ll be focusing on buyers and what you need to know and do before you purchase your next home. Each post will provide information or an actionable item that you as a home buyer should know. Buying a home can seem like an intimidating process, especially if it’s your first time buying. We are bombarded by information on the internet (like this) and sources like HGTV. While entertaining, they often gloss over the basics and tangible to-dos. In this post, we’ll tackle debt-to-income ratios and what they should mean to you.
One of the first steps to buying a home is to sit down with a lender or creditor to determine how much money you are financially able to spend on a house. This is an essential first step, because it allows you to be realistic in what you can afford. It also helps your agent choose homes within your financial range. When you meet with the lender, our debt-to-income ratio is likely to be one of the first topics of discussion. So what does that mean? Debt-to-income ratio is this: all your monthly debt payments divided by your gross monthly income. Although it seems easy enough, let’s drill down and unpack this more.
First, what counts as monthly debt? Monthly debt includes minimum monthly credit card payments, student loans, alimony / child support, car payments, any house payments (rental or mortgage), and any other personal loans with periodic payments. Things NOT to include in monthly debt: credit balances if paid in full each month and existing house payments that will be obsolete (if you currently own a home and are planning to sell before you purchase another home or property).
Second, what is your gross monthly income? Your gross income is what you are paid before any deductions – this includes insurance, taxes, and 401k payments.
In a best case scenario, almost all lenders prefer or require a debt-to-income ratio less than 43%. This is a protection for them so you don’t overextend yourself as a buyer.
Knowing your debt-to-income ratio can be a great tool even if you’re not quite ready to purchase a home. If you’ve already calculated it, and you’re below 43%, congratulations! You are one step closer to purchasing your home. If you’re not below 43%, or feel it’s higher than you’d like, there are a few things you can do to lower your monthly debts including:
- Increase the amount you pay on your debt each month. Extra payments will lower debt thus lowering your debt-to-income ratio.
- Postpone larger purchases until after you’ve bought a home. Buying items such as cars or other recreational items (trailers, boats, and the like) can delay the purchase of a home by months or even longer, depending on the size of the purchase.
- Along with this, avoid additional debt in any form – typically associated with credit cards and purchases that building over time.
- Increase your income. This can be a great opportunity to ask for a raise or salary increase. Working overtime or picking up a side job are also options.
Sometimes the thought of having more work on top of an already busy schedule can be daunting or feel impossible, especially if you have kids or other life responsibilities. Lowering or improving your debt-to-income ratio may seem intimidating. It’s okay. We understand that life happens. If this is the case, this is where working with your lender and your agent is a must. As your agent, it is our job to represent you and work for you. Our goal is to make the home-buying process as smooth as possible.
If this has been helpful or you have more questions regarding debt-to-income ratio, let us know! We’d love to help you move forward wherever you are in the home buying process.