If you are buying a home, you need to learn what a debt-to-income ratio is and the significance of the number 43%. What does that all mean? It simply means that this is how lenders decide if they are going to give you any more and if so, how much. When you apply for a loan, lenders will take into account tons of information about you, especially your finances, to determine if the loan makes sense for them.

Because everyone is different, lenders need a way to compare everyone beyond just their credit score. One of the key indicators and best ways to determine if someone can afford to pay off a loan is by looking at the debt-to-income ratio, where your income is put up against your debt to determine what you can afford to pay every month and what you cannot.

What Exactly Is Debt-To-Income Ratio?

If you are making $4,000 a month and you are paying $500 a month towards your car payment and another $500 a month towards your credit card, lenders view that as a $4,000 a month income against $1,000 of debt. That means your debt currently takes up 25% of your income, which is not bad. Banks will not count things like your cable subscription or your current rent because those things are not expenses you are stuck with, unlike debt.

It’s important to keep your debt as low as possible and anything can influence it including buying furniture or financing a new television. Keeping the money you owe as low as possible when you apply is important because lenders take these numbers and compare them with what the cost of your mortgage will be every month. If the cost pushes your ratio over 43%, you probably will not get the mortgage.

How Does It Impact Buying A Home?

When you apply for a mortgage, the lender has to see how much lending you the money will cost you each month based on a variety of factors. The first is how much you are putting down. If you are not able to put at least 20% down on the property, then you have to pay a mortgage insurance which can be anywhere from $100 to $400 a month added to your payments. This amount does count towards your ratio as well. Next, they look at your credit score and current interest rates to determine what you will pay monthly for the money you borrowed. Finally, they factor in the amount you are borrowing and how long the loan is listed for.

After all that, they add your current debt to the amount and see if it covers more than 43% of your income. If it does, they usually are not interested in giving out the loan because it shows that you will have a real struggle paying it. Buyers have literally lost deals at the last minute because the insurance premiums have pushed their ratio too high. That’s why it’s important to keep your ratio down as much as possible, especially if you want to buy a home.

How To Quickly Improve Your Ratio

If you are planning to buy a home and are concerned that you are not going to have the best numbers, there are plenty of things you can do, especially in a short period of time. One of the first things you need to do is pay off those credit cards. While people worry about how much they owe on cars, it’s the credit card balance that can actually throw off your numbers more. Why? Because even if both payments are exactly the same each month, lenders see the car payment as something that will end relatively soon. However, credit card debt will be around for years and if you owe $500 a month right now, chances are that number will go up if you buy a home.

Cutting down debt may require you to use some of your savings which means you will have less to put down on the property. Even if that’s the case, it still may be the better play, especially if your debt is too high and is pushing your numbers too high as well. While you’re not crazy about the idea of borrowing even more money, it may be the only way you get approved for the amount you need to buy the home.

What Else Will Lenders Look At?

Aside from the income-to-debt ratio, lenders want to know things like who you work with, how long you’ve been showing that you can make the money you’ve been making if you’ve ever purchased a home before as well as your credit score. All of these things will impact whether or not a lender wants to work with you and keep in mind, your lender may not stick with you long. In fact, banks are known for selling mortgages to other financial institutions which is not something that will impact what you pay but rather, who you pay. Your mortgage could literally be sold before you even sign the closing papers, so remember that while a bank may want to work with you, at the end of the day it’s your numbers that matter.

When you speak to a realtor about buying a home, these are some of the things they will discuss with you to see if you are eligible and what areas you can work on. Because it literally can take months to find and close on the home you want, it’s good to get started on fixing your finances as soon as possible because they could help you not only get the loan but save big as well.

Making some of these changes and improving your numbers could cut your monthly costs down by $500 or more as far as what your mortgage costs you. That difference will be counted against your ratio, which means you can borrow more money if needed and as long as that ratio stays under 43%.