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Debt to Income

by | Buying

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So in a previous video you might remember that I  talked about improving your credit score in order to qualify for a mortgage. In that video I talked  about debt to income ratios. So in this video I want to go a little deeper into that and help  you calculate what your debt to income ratio is.

 

I’ve created a super simple spreadsheet that I’m  going to share with you in the description I’ll put a link to it in the description below. Where  you can figure out your debt to income what it is today. I also want to caution you because you  know the lender’s going to tell you that they need to see a debt to income ratio of a certain amount  it might be you know 42 it could be all the way up to like 55 percent but even if they say that you can afford it I want you to think about it on your own and for  yourself. You need to decide if you can afford it because you’re the one committing  in most cases 30 years of paying that debt back.

 

So you got to be comfortable with it and a lot  of people just take whatever the lender tells them and says “Oh look I can buy this house and  this is my debt and they say I can afford it so I’m good”. But a lot of people find that that wasn’t the best way to go and that you might have other plans you might not want to keep you know working  as hard as you are right now for the next 30 years and you might want to just buy a little less house  than you can qualify for and that’s perfectly okay to do just because they tell you this is the  maximum amount you can get does not mean that you have to spend the maximum amount and I want you to  not spend the maximum amount if you don’t have to.

 

So let’s go ahead and take a look at the  spreadsheet I have for determining your debt to income ratio and then you’ll be able to  download it yourself and try it out for yourself so here’s the spreadsheet for the debt to income  ratio.

 

As you can see up here at the top it says income sources so this is any income that  you have that you’re going to use to qualify for that mortgage you want to put that in here. To make it simple on this video let’s just go with an annual salary. Let’s say you have an annual  salary of a $100,000 a year.

 

There’s another category here because  sometimes a lot of people have extra income. Maybe you get an annual bonus  and it’s really consistent and you’ve gotten it every year. For the last 10 years maybe you have a  side job maybe you have an extra weekend job that you do, it is if you’ve  been doing it for a few years and it’s something that you know you’re going to continue doing  then let’s go ahead and add that in as well so let’s just say you make another $10,000 a year doing whatever that extra income is.

 

Let’s look at debt sources so we’re going to leave this blank right here for the mortgage because we don’t yet know how much money you’re going to  spend on a mortgage so we’ll get to that at the end but let’s take a look at other debts that you have and you know car loans maybe you have an RV or a boat or a motorcycle.

 

Let’s make some assumptions let’s say assume you have a car loan of $300 a month and we’re gonna put that in the monthly category so it  calculates correctly. Let’s say you have I don’t know you bought a boat and it’s $200 a month and let’s say you have some a little bit of credit card dad that you carry over and you’re not  planning to pay it off before you get a mortgage and let’s say that’s another $200 a month and let’s  say that you went to college and you didn’t pay off all your debt yet and you still have several  years left before that gets paid off and you have let’s say $400 a month of student loan debt.

 

If there’s any other debt that you can think of that’s monthly that’s going to come up and I’m  not talking about electricity bills or gas for your car or maintenance for your car or cellphone. Nothing like that those aren’t monthly debts from money that you borrowed those are just  living expenses so let’s not calculate that in. So what we have there is $1,100 a  month in debt and an income of $110,000.

 

Remember this income  is before taxes this is not your after tax income so this is your gross income. That gives you a debt to income ratio of 12% which is amazing it’s 12% very low. However we’re not  factoring in what your mortgage is or what your rent might be so we’re not even considering that yet at this point.

 

So let’s say you have save some money for a down payment and you’re ready to buy a house and in California things are expensive. Let’s say you  are going to buy a house for $700,000 and you need a down payment of 20% now not every loan requires 20% down. Let’s say you have a 20% down payment  so you’re looking at a mortgage amount of $560,000 let’s plug that in. Remember  it’s a 30-year loan in most cases unless you have a really big down payment or a really big income  and you can afford a 15-year mortgage let’s go with a 30-year mortgage.

 

At an interest rate let’s say it’s 3.5 because that’s what’s projected by California association realtors to happen  by the end of 2022 they anticipate that 3.5 is where mortgage rates are going to be in 2022.

 

Now let’s add in property tax it’s going to be different depending on what county, what city, what state it’s going to depend on that. I’m going to put $8,400 for a $700,000 house and annual homeowners insurance let’s just say a $1,000 depends on  what options you pick how much coverage you have, how low your deductible is. Those are all variables  when you choose insurance so let’s just go with a round number of a thousand. And what we have here is a payment a monthly payment of $2514.65. That is just principal and interest that  doesn’t include the taxes and the insurance. So if we want that number which is the PITI that  goes to $3297.98

 

Let’s take that number and edit it back into the spreadsheet and see what the  debt to income ratio is now. Our debt to income ratio now is 47.98%. That’s a little bit high and remember that this is an amount of your based on your income before your income taxes taken from your paycheck.

 

Could you qualify at this amount? Yes! There are lenders out there that will lend to you at this debt to income ratio. Should you take a loan at this amount? I’d be real hesitant to do it because you’re committing to 30  years and once you factor in your income tax, that’s going to be way more than 50 of your  income so really be cautious

 

What could you do to change this? Let’s say in your area that  $700,000 price point is barely gonna get you into a house that you want. What can you do to fix that? Well one thing that you can do is get rid of some of this debt.

 

I know that everybody likes a new car but you can’t live in your car. Your car is not going to help you and that car is only going to go down in value so if you could pay off that $300 a month car loan and still keep driving that car. That would help significantly.

 

Let’s say you have no car loans take that out how  does that change it so it changes it down to 44.71%. That’s a big improvement. What if  you just get rid of that whatever you got, your boat, your motorcycle, your RV, whatever that is, do you really need it? Wouldn’t you rather put that $200 a month towards your house by maybe fixing it up or saving for a rainy day in case the roof leaks  or something happens?

 

Let’s take that out now we’re getting down to close to 42% and this is right in the number where I think most lenders prefer to see. If you could pay off those credit cards, how much better would that be for you? Now you’re at 40% which is much more doable than than close to 50.

 

I think this is a good number to be at and I just wanted to show you how much it can matter for you by having that car loan, the credit card debt, it makes a significant impact on the  house you can buy and you got to decide like what is more important to you and that’s how you use a  debt to income calculator.