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How Much Does Debt-to-Income Matter?

How Much Does Debt-to-Income Matter?

Jun 13, 2022 My Blog by Chester Ray

A debt-to-income ratio is the comparison of one’s gross monthly income to what one spends every month. Generally, the higher the percentage, the less likely an individual will be able to afford repayment for any debts incurred. For example, if your gross monthly income is $5,000 and you spend $4,500 every month, your debt-to-income ratio would be (5/4)*100 = 125%.

What Is The 43% Debt-To-Income Ratio

The “43” is shorthand for the maximum debt-to-income proportion that Fannie Mae and Freddie Mac will let. It mostly applies to borrowers applying to buying a home or refinance an current mortgage. For example, if you have a gross monthly income of $3,500 and want to purchase a home with a $300,000 mortgage, your debt-to-income ratio would be (3,500/300)*100 = 43%. Fannie Mae and Freddie Mac will reject almost any application if the applicant’s debt-to-income ratio exceeds their limit.

What Is A Safe Debt-To-Income Ratio

A healthy debt-to-income ratio should be in the range of 43%-48%. For example, if your gross monthly income is $5,000 and your spend $4,500 every month, your debt to income ratio would be (5/4)*100 = 125%. Although it may be safe for your lender, lending 125% of your income can cause several problems. First of all, if you owe more than you make and don’t have a plan (job loss, health problems), it’s possible to fall behind on payments and have your home foreclosed. Additionally, if something unexpected occurs (car repair, health problem), you may not be able to pay for it.

Does The Debt-To-Income Ratio Matters

A debt-to-income ratio greater than 43% will likely cause lenders to reject your application to borrow money. You must understand what a safe amount is and keep it within that range. If you wish to borrow money, be sure you can comfortably make the payments on whatever it is you’re borrowing. If you cannot afford the payments, consider alternatives like saving until you can pay for it in cash.

Although a debt-to-income ratio doesn’t apply to most personal purchases, it does matter for those that involve borrowing. Lenders will be more likely to set their debt-to-income ratios high, which increases the risk of default and foreclosure. Be sure to understand how much of your income you can afford to spend every month before asking a lender for a loan.