Do you own a home, or do you want to buy a home someday? If so, it's essential to understand how your debt-to-income ratio can affect how much home you can afford. Understanding your debt-to-income ratio can prepare you to make changes to your current debt and future savings methods. It can also help you achieve the "American Dream" of homeownership.
Why Debt-To-Income Ratio Matters
Your home can be your largest asset and your most significant investment. Understanding your debt-to-income ratio can ensure that you can afford to pay for a future mortgage and enable you to retain your investment. Evaluating your budget and looking at your current and future financial situation can help you determine how much debt you can afford and be comfortable with. Financial institutions will also use this same method when determining the loan amount you are eligible for.
Understanding & Calculating Your Debt-To-Income Ratio
Your debt-to-income ratio evaluates how much you owe to creditors compared to your gross monthly income. You can calculate it by dividing all of your recurring monthly debt payments by your before-tax income. For example, if your total monthly debt is $1,000 and your monthly income is $4,000, your debt-to-income ratio will be 25%. Most experts recommend that a healthy ratio is below 35% but that no more than 40% should go towards all debt payments, including a mortgage. Consider this rule of thumb when evaluating your next large purchase.
Calculate your DTI Ratio here.