Looking to buy or refinance? Pay attention to the number 43.
If you are considering buying a home or refinancing an existing mortgage, here’s one number that is particularly important: 43.
When you are determining how much you can afford to borrow, you and your lender will want to add up all of your monthly income and add up all of your monthly debt payments, such as credit cards, student loans, and auto loans. Your total debt payments relative to your total income is called your debt-to-income ratio.
So where does 43 come in?
When you go to buy a home or refinance, lenders generally want you to hold your DTI below 43%. A DTI of 43 means that for every $100 in income, you are spending $43 on debt and have $57 left for buying groceries, eating out, vacations and other expenses, as well as savings.
Here’s an example. Let’s say you earn $5,000 a month. If your only debt is a car loan and the payment is $500 a month, then you have a debt-to-income ratio of 10% — a nice healthy ratio. The lower your ratio, the better generally because that indicates you are living within your means, managing your finances, and not spending an inordinate amount of your income on debt payments.
If you are spending more than 43% of your monthly income to pay debt, you may be stretching your finances too thin. The federal Consumer Financial Protection Bureau (CFPB) says studies of mortgage loans suggest borrowers with a higher debt-to-income ratio are more likely to run into trouble making monthly payments.
Lenders under some circumstances may approve loans with a DTI above 43%. However, these loans are considered more risky, and the lender is responsible for verifying the borrower’s ability to repay.
The bottom line is you should have a general idea of what your total debt payments are each month and your total income, and then consider your debt-to-income ratio. Using 43% as the maximum DTI is a good general guide to help avoid becoming over-extended.