What is a Debt-To-Income Ratio?

Financing

Most industries have their own technical speak which may confuse people who aren’t overly familiar with the business. Have you ever listened to two doctors have a conversation? Or two meteorologists? I once sat a table with three quantum physicists; I probably could have understood more chatting with three Spanish speaking individuals and I don’t speak Spanish.


The real estate business is no different. We’ve got our own set of terms, which, to the average person unfamiliar with realty, may sound bizarre and confusing. Not only that, but we’ve got our own mathematics ratios, ones you were never taught in high school (unless your parent was a realtor). A good example of this would be the equation of the debt-to-income ratio. What’s a debt-to-income ratio you ask? Basically, it’s a tool to figure out how much you can afford to spend on a house, even before you start house hunting.


With this equation, mortgage lenders are able to determine how much money you can afford to borrow. To determine this ratio, first we are going to figure out the percentage of your monthly gross income used to pay for your housing costs, like interest, taxes, insurance, principal, mortgage insurance and/or homeowner’s association fees. The second number we are acquiring is representative of your monthly consumer debt, which is basically things like loans, credit card debt, ect, added to the first number.


Now, let’s get these numbers in a ratio format. For example, if we had a debt-to-income ratio of 30/38, 30 percent of our income would be spent on monthly living expenses, while eight percent is spent on monthly consumer debt. The 38 is your eight percent consumer debt added to the first number in the ratio. 30 plus 8 equals 38, unless math has changed since I was a little girl.

 

Different institutions have different requirements for your debt-to-income ratio. 33/38 is a common one, as is 29/41. Some institutions don’t even require a first number in the ratio, and only demand a back ratio of whatever they find a safe investment.


Don’t assume your debt-to-income ratio only influences your ability to purchase a home! It is used as a tool to establish your credit and financial stability by many. At all times, know your ratio, and work towards keeping it as low as you possibly can. If your consumer debt number gets higher than 20 percent, you know you need to fix that faster than a leaky faucet. Why? Well, with a consumer debt number higher than 20 percent, you may find it difficult to get yourself a new home, car, or even that new Samsung refrigerator which links to your phone. In addition, if you do get something, your interest rates are going to be as atrocious as the Wicked Witch of the West. You’ll find getting more credit near impossible, so don’t even try applying for cards if your consumer debt ratio is about 20. As you can see, the debt-to-income ratio isn’t just a tool for lenders, but for yourself! Use it wisely, be a smart spender, and you’ll find navigating the adult world around you much easier than if you were ignoring the ratio altogether.