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Q: I’ve been advised to create a debt-to-income ratio. How do I do this?
A: Your debt-to-income ratio is calculated on a monthly basis. You add up all of your monthly payments towards loans and debts (such as credit card and mortgage payments) and divide by your gross income (before-tax income). Move the decimal two places to the right, and you have the percentage of your income that goes to pay off your debts each month.
Debt-to-income ratios are often used by potential lenders who want to know if you will be able to afford to repay your loan.
www.Bankrate.com, as well as other experts, recommends that your debt-to-income ratio be below 36%. If it is below 36% and your credit score is fairly good, you should be able to qualify for a home or get a credit card at a reasonable rate.
Additionally, no more than 28% of this amount should go to your house payment.
Next time you’re shopping for a house (or a car, or anything else that requires a loan), do some simple calculations. Multiply your monthly gross income by 0.28 to see the maximum amount you should pay toward your mortgage payment each month.
Then enlist your realtor’s help in finding a home that fits into your budget.
When shopping for a different type of loan, multiply your gross income by 0.36 and make sure the monthly payments won’t put you over that limit.
If you follow these simple guidelines, you will look good to lenders, and, more importantly, you’ll help keep your household financially healthy.