The debt to income ratio is the amount of debt you have compared to how much money you make each month. Before giving you a mortgage on your house, the lender will usually look at the ratio of your debts to your income to figure out if you qualify for the mortgage. The ratio is compared to two qualifying numbers, which are 28 and 36. The chances of getting a loan go down as the ratio goes up.
The number 28 refers to the most of your monthly income that the lender will let you use to pay for housing. This includes the loan's principal and interest, private mortgage insurance, property tax, and other costs like home association fees.
The number 36 shows the maximum amount of your monthly income that the lender will let you spend on housing costs and recurring expenses like credit card payments, car loans, student loans, or any other bills that won't be paid off right away after you get a mortgage.
Let's look at the case of a borrower who makes $4,000 a month.
28 percent of $4,000 is $1120, so $1120 will be given to cover housing costs.
36 percent of $4,000 is $1440, which means that $1440 will be given for both housing and regular costs. This means the person can't owe more than $320 in other debts.
Some loans have higher interest rates, which let you take on more debt. For example, the eligibility for an FHA loan is based on a 29/42 scale.
Most banks will not work with you if your debt-to-income ratio is above 36%. If it's more than 43 percent, you might have trouble paying your bills in the future, and if it's 50 percent or more, you should figure out how to pay off your debts right away before applying for a mortgage.
A lot of interesting things can be said about the debt ratio. Let's look at the facts about a person who makes $3,000 a month and doesn't have any other bills to pay. With a debt ratio of 38%, the amount that can be used for the mortgage is $1140.
On the other hand, let's say you make $4,000 a month and owe $1,000. After taking the $1000 debt out of your monthly income, if you still think you deserve the $1140 for the mortgage, you are wrong. The bank doesn't just keep track of the numbers; it also looks at the percentage. You will be given $1,520 (38 percent of $4,000) per month to pay off your debts, including your mortgage. So, once you take out the $1000 for other loans, you only have $520 left for the mortgage!
In conclusion, it is best to pay off as much debt as possible. Banks don't care about how much money you make; what they care about is how much of it you spend. You should also think about how much you can save for a down payment. If you pay off all your debts but don't save for a down payment, you might find yourself in a worse situation. In this case, you should talk to a mortgage counsellor to figure out if it would be better to save for the down payment or pay off the debts.
