For Buyers: Measuring Your Ratio of Debt to Equity is Essential But Not Complicated
Bankrate dot com is a website that I occasionally visit during my week. It offers general financial information, indexes, and trends beyond simple real estate. (Note: the site seems to be supported by advertising and "pop ups". The Firefox web browser is impregnable to such annoyances, I cannot speak for other browser experiences such as Internet Explorer, Netscape, etc).
Recently Bankrate revisited an oldie but a goodie from when I was in real estate school in an article entitled "Debt-to-income ratio important as credit score". Don't let the title scare you off, the concepts involved here go no farther than grammar school arithmetic, so anyone can come up with this measure of personal financial viability in the housing market in just a few minutes. This is nothing more than simple addition and division.
Simply put, your debt to income ratio can be defined as follows:
Divide all of your "recurring debt" by your total monthly income, the result is a percentage and loan officers mostly look for this number to be less than 36%. "Recurring debt" ONLY includes monthly payments such as mortgage or rent, (Mortgage should include PITI, that is, principal + interest + taxes + insurance), payments for home equity loans, minimum payments on credit card debt, student loan payments, automobile loans, and any other types of loans. Recurring debt does not include transportation, gasoline, food, entertainment, dry cleaning and other day to day living expenses.
Let's look at a couple who earns $125,000/year, which would be $10,416.66/month. If this couple has a mortgage payment of $1,600/month, plus two automobile loans which total $750/month, minimum credit card payments of $329/month, and student loans of $102/month, then their "recurring debt" would be $2,781/month. Their debt to equity ratio is then $2,781/$10,416.66 = 26.7%.
This is a healthy situation for our mythical couple because the majority of loan officers use 36% as an indication of risk on the part of the lender. Understanding this simple concept can be an aid when considering what kinds of homes one should be viewing in the case of a new purchase. Simply multiply your monthly income by 36%, and this number will be your maximum recurring debt. from here, it is a simple step to determine the maximum amount of mortgage payment that you can undertake, and in turn, the price range of homes that are within your reach as far as a lending instituion would be concerned.
Bankrate has a debt to equity calculator at this link, and whole series of financial calulators at this location.
As a final note on debt, should you or anyone you know ever need debt management, my advice is to follow this maxim: It is not necessary to pay money to a debt relief firm for help. There is nothing that anyone can do for you for money, that you cannot do yourself for free. The Federal Trade Commission offers a heap of consumer advice on this and other consumer topics at this link.
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Filed in the: Tips for Buyers Archive