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What is Your Debt-to-Income Ratio?

About Debt

James and Mary have been married for ten years now - both are professionals in their field of work, and both make very good money, having been working for the same employer for more than five years. During the years of their marriage they have lived in a few apartment buildings but have finally decided, now that they are settled into their career and their new lives, they want to start a family, and in order to do that - they figure it's time to buy their first home together.

Well they figure buying a home should be relatively easy, their combined monthly income is more than $20,000 and the home they have set their hearts on is close to Mary's parents who will of course provide regular babysitting when the children arrive. The house only costs $300,000, and they have a 10% down payment they can make in cash. When they approach a lender to get pre-approved for their house they are turned down flat. Embarrassed and angry, they turn to another lender without looking carefully at the reason they were rejected by the first. Again, the lender refuses to give them the loan for their house. What could possibly be the problem?

High Debt-to-Income Ratio Problems

Debt-to-Income Ratio is a serious problem in society today that many people do not pay enough attention to. The focus in many homes tends to be on income alone, and as long as debt doesn't overwhelm, it's fine and manageable, right? Wrong! Banks and lending institutions are very specifically concerned about the debt to income ratio of all of their borrowers and potential borrowers, and it stops people from getting loans on cars, houses and credit cards every day.

What is the Debt-to-Income Ratio?

Debt to income ratio is a measure of what percentage of your income is being swallowed by debt every month. The ideal amount of debt that should be carried every month is less than 35%. This includes your home payment and all of your credit-based bills such as car payments, credit cards and other loans versus your total monthly income.

Once you have added up all of your debts and taken them as a percentage of your income, you will have your debt-to-income ratio. Here's how many lenders will view the number you come up with:

  • 35% or less: Your debt load is fine. Keeping the amount of debts you have to less than 35% of your income shows lenders that you know how to manage your spending habits wisely compared to the amount of income you have - you are very credit-worthy.
  • 34%-41%: Doesn't feel that bad to most people in this society where we are used to having debt, but the fact is that this something of a precarious position to be in. If you wanted to get a credit card you probably could but personal loans may be difficult to come by at this point.
  • 42%-49%: Not good at all. This kind of debt-to-income ratio is simply scary to most lenders and they will tend to avoid you. You may be pulling off your payments every month but understand that asking for more debt on top of that seems like an absurd proposition to the banks.
  • more than 50%: You need help. Consider a debt management company or consolidation to bring your debt down quickly if you cannot do it on your own.
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