All Posts Tagged: debt-to-income ratio

Numbers Count: Why 43 is such an important number

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Numbers count. They matter to bankers and to prospective homebuyers, sellers, and real estate professionals. Here’s my take on the key numbers on the housing market this week.

Hands of man shopping online with a digital tablet

The numbers: Consumers continue to take on more debt, according to the latest Federal Reserve report. Consumer credit increased 5.75% during the fourth quarter, according to data released Feb. 5 by the Federal Reserve. Credit card debt, or revolving credit, increased at an annual rate of 5.25%, while non-revolving credit, including auto loans and student loans, increased 6%.

What counts: If you are considering buying a home or refinancing, keep in mind the number 43.

In the mortgage world that is an important number. Here’s why. Additional borrowing affects your financial picture. One primary impact is your debt-to-income ratio, which every homebuyer and owner should become familiar with. I’ve talked about it before, but let’s dig in a bit deeper. Your debt-to-income (DTI) ratio compares your total monthly debt payments — including credit cards, car payments, student loans, and property taxes if you own property — to your monthly income, including salary, government benefits, investment income, etc.

Let’s say, for example, 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.

When you go to buy a home or refinance, lenders generally want you to hold your DTI below 43%. 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.

So, in a more elaborate example, if you pay $1,500 a month for your mortgage and another $100 a month for an auto loan and $400 a month for the rest of your debts, your monthly debt payments are $2000. If your gross monthly income is $6,000, then your debt-to-income ratio is 33% ($2,000 is 33% of $6,000).

Lenders under some circumstances may approve loans with a DTI above 43%, but these loans are considered more risky and the lender must verify the borrower’s ability to repay. Still, you won’t know if you qualify unless you apply.

The bottom line is you should have a general idea of what your total debt payments are each month, what your total income is, and be aware of your debt-to-income ratio. Using 43% as the maximum DTI is a good general guide to help avoid becoming over-extended.

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