What is it and why you need to know about it
Whether you are buying or building your dream home you need to know about debt-to-income ratio. This number, in conjunction with the size of your down payment, will determine how big of a loan (mortgage) you can qualify for.
Debt-to-income ratio is usually reported as a percentage. It is calculated using your monthly recurring debt and your monthly gross income. The equation: monthly debt/gross income x100 = percentage of debt-to-income ratio. Example: $2500/$6000 = 42%
What counts as debt?
Do all your monthly bills get included? Just certain ones? I’m glad you asked! Debt in this equation includes the following:
– Mortgage payment
– Car payment
– Student loans
– Credit cards (unpaid balances)
– Any other loans/financed debts you’ve accrued
What if you already have 1, 2, or 10 debts you are paying every month? Consider paying down your debt using this advice or debt snowballing. Try these 11 strategies to save money while you pay down your debt. Reducing your debt will increase the amount of money the bank is willing to loan you for your dream home. If you have significant debt you may need to start the process of eliminating debt at least a year before you purchase or start building your dream home. Don’t wait until you are ready to start looking at house to take a look at your debt!
One reasons we try our best to pay cash for cars and live below our means is so when it’s time to qualify for our construction loan we will be approved for the largest amount possible under our income bracket. We have been consciously avoiding debt and saving for a down payment for 4 years. Planning for your future is crucial and never too early to start!
Ideal debt-to-income ratio
What’s the goal debt-to-income ratio? To qualify for a conventional loan banks will want your debt-to-income ratio less than 36%. Some may have stricter levels or more lenient ones depending on the type of loans you can qualify for. Typically the highest percentage you will find approved is 41% for special FHA loans. Also, the amount of down payment you can provide and your credit score may affect approved loans for you. Talk to a lender to learn more about the special requirements in your area.
You can google to find a mortgage calculator to determine the monthly payment on a home in the price range you’re planning. A good mortgage calculator will include total home cost, minus the down payment, interest rates, and the option to choose 15 year or 30 year payback periods. Add the monthly payment to your other monthly debt (or replace your current mortgage payment to a larger one) to determine if it will fit in your debt-to-income ratio.
Planning for your dream home
Start planning ASAP! You will need to determine what your dream home looks like in vague terms: How big? Fancy editions? Track home or custom design? Lot size? These will effect the total price of your house. Once you have your initial dream home idea you can then determine the size down payment you will need and how much debt you will need to pay off to reach your dreams. You may also need to look at ways to increase your income. You can search Zillow or visit open houses in your area to get an idea of the housing market there.
Bottom line. When it comes to obtaining your dream home – debt is your enemy and planning is your friend!
What are your best tips for staying out of debt?
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