One of the contributing factors to the nationwide subprime mortgage crisis in the mid-2000s was the fact that Americans were accumulating more debt than ever before. That wasn’t the only factor, mind you. But from 1990 to 2007, the average ratio of household debt-to-income, including mortgage related debt, rose from 77% to 127%.
What is debt-to-income ratio? It is a calculation used by lenders to determine your risk as a borrower. This is good intel to have about yourself before you set out to buy a home and apply for a mortgage. You determine your household debt-to-income ratio by tallying your monthly debt payments and dividing that figure by your gross monthly income. Your gross income is the amount of your paycheck before any deductions (such as taxes, health insurance, etc.).
How do you calculate your debt-to-income ratio? Some simple math – if you have a total of $2,500 you pay in rents, car/student loans/other loans, credit card other debt, and your gross monthly income is $6,500, then divide $2,500 by $6,500 and your debt-to-income ratio is about 34.5 percent. You know, what $ goes out divided by what $ is coming in.
Who looks at debt-to-income ratios? Lenders! They use that as one indicator of your ability to manage your payments and make consistent monthly payments on your loan. The higher the percentage on your debt-to-income ratio, the higher lending risk you become in their estimation. That’s not to say you wouldn’t get a loan, but there could be more financial risks and hardships attached to those loans.
What is a good percentage of debt to income ratio? Lenders generally are looking for borrowers that have a debt-to-income ratio of 43 percent or lower. This is because, generally, 43 percent is the highest ratio lenders will comfortably consider when offering a qualified mortgage. You’ll want to strive for a Qualified Mortgage when looking at (for example) homes for sale in Fresno, the San Joaquin Valley and across California, because a Qualified Mortgage will have certain stable features and affordability in comparison to the other various types of home loans out there.
You can easily calculate your debt-to-income ratio and other math related to home buying and loan borrowing, using an online mortgage calculator on internet-based real estate and rental marketplaces. If your debt to income ratio is higher than 43 percent, you may want to consider focusing on winnowing that number down before applying for a mortgage loan, and position yourself for better options and terms in the long run.