Welcome together, we're gonna explore our personal finances and figure out how to improve them. Whether you're just getting started in life on your finances, or you may already have a home and a car payment, and you're struggling to get credit cards under control, or you again in a later start in life on saving for retirement, reduce debt increase. wealth.com is a podcast to educate those to improve personal finances, whether it's eliminating debt, or making smart investments. Hello, Mr. Chuck here, in this episode, we're gonna be talking about the debt to income ratio. What is it? And how do you compute the ratio? Who uses it, and what's it good for. But before I get started and talking about that, I want to do a follow up on I talked about last episode about my medical provider and setting up a payment plan was a good thing I did that and didn't deplete my emergency fund went in main reason I did is because one every can get a interest free loan and pay it off over time, you can then extend the use of your emergency fund. And course it's free money, he can put it all pan it. And it turns out to be a good thing. But in this month, I have a lot of insurance Do I have homeowners insurance due for the year I got motorcycle insurance due for the year. And I got two car policies due this month for six months. So I call it I'm insurance poor this month, even though I have the money saved up, it stole insurance poor. If I were to use my emergency fund to pay off my medical provider, then I would become up a little bit short when I after I pay off all that insurance I'm gonna owe this month. So it was just a note of that by not paying all that all off at once I have extra money in my emergency fund to come up with this short each I'm going to come up with this month to pay my insurance obligations that I can't do this month. So income debt to income ratio. Let's get started on that. What is it? And what does that mean? How do you compute the ratio and why it's good to know and who uses the ratio is the topic I'm gonna be speaking about. So with that said, we're going to get right into it. I have a couple articles. It's in my show notes. If you go to my website, reduce that increase wealth.com. He can see my show notes which I have links and some of the directories also have them and the links in there too. What is the debt to income ratio? Why is it important? The debt to income ratio is all your monthly debt payments divided by your gross monthly income. This number is one way lenders measure your ability to manage the monthly payments to repay the money you plan to borrow. And so when you go out and apply for a loan, and you probably notice, they ask you how much you make. What's your monthly income. When you when you're getting asked that when you're applying for a loan, you need to tell them your gross income, which is before taxes, and any other deductions such as health insurance, or other deductions you may have coming out of your paycheck as that gross number. And that's important. And then they go to the credit bureau and find out what your outstanding debt is and that's why they have a account with credit bureaus. And they might ask you how much other debt you have, but they're gonna check that and they divide your total monthly debt by buy your gross income and come up with a percentage. That percentage is what they use to determine whether or not you can afford this loan or not. As long as along with your credit score and your credit score also is looking at your on time payments, how long you've had debt, what percent of the debt you owe on If all those numbers look good, they approve you for your loan, you get your new car and off you go. So that's important for creditors use that. Or whenever you're applying for a loan or maybe refinancing your mortgage, or applying to get a mortgage to buy your first home, that's the number they're gonna be looking at. So we're gonna talk about what that is included? Well, it's simple. I mean, it's, it's simple. To me, it's all debt, which I'm going to give you a list and your mortgage on your home, your second mortgage on a home or any line of credit, car loan, car loans, if you got more than one, boat loans, student loans student and, you know, from college loans, your student loans or any personal loans. And if you have payday loans worse the end of the month, and it's not paid off, and you should include that number also, I need divide your gross income into that number. It's, again, it's your you know, for a month, it's the total amount you make before deductions before taxes, and then any other deductions. And you come up with a percentage, if you're going out to apply for to buy your first home, they get your first mortgage, let's say and you're renting an apartment and your apartment rent is say, just say 50% of your income. The good news is when you apply for that first mortgage, they're not including the rent for that apartment, in this calculation, so you're gonna look good, and you're gonna look a whole lot better than if they included your rent. So if you're renting in any way, shape or form, that is not included. Also any utility bills you may pay, or regular monthly bills you pay are not included because not considered debt. But if you're making late payments on them, or hadn't paid them, that's gonna be reflected on your credit score. And a bad credit scores can prevent you from getting that mortgage. So you need two things, you need a good debt to income ratio, and you need a good credit score. Assuming you have a good credit score, you know, above average, you're doing good, you pay all your bills on time, you don't have a whole lot of credit card debt and what you do have maybe you have one card you pay off every month. So you know, you figure you're doing pretty good. So just giving you an example, I figured out what my debt to income ratio was. The only thing in my mind that I owe is my first mortgage, I have all my other debt paid off. So when I take that monthly payment by my gross payment, gross income for the month, and I did this for June of 2020 I have 10% that is really good, that's low. What that means is my debt is only 10% of my monthly income by got 90% of my income to pay everything else if I would go out to buy a new car and want a loan on it. Now real quick and easy cuz I got a real good debt ratio. And then I thought well I do use a credit card that I charge two to $300 a month on the pay stuff that I could actually be paying, you know off and not putting through a credit card. And I pay that credit card like on second of every month I threw that number in there for for the month of June is the month I used. I bought a new iPhone, and I had some other expenses. So I had a big balance that I paid off debt to income ratio for the month of June including my unpaid balance on the credit card. As of the end of June, I would had like a 46% which means I only had 46% of my monthly income in June was going to debt. That's not so good. It's not bad. It's not good. But then I decided I miss figure it out based on my average which is like two to $300 and I fall around 16% which is still fairly good. To give you an idea. We're going to go over what's good and what's bad here in a second. But the number that you need to know if you're looking to buy a home may even refine is the percentage that your mortgage companies are looking for is anything below 43%. And the farther below farther below it, the better off, you're gonna be. If you're right at 43%, you might find somebody, but you might have to shop around, you may not get the lowest rate, you may not get the best one out there, what they really want. And we talked about this and budgeting, how much should you be budgeting, your monthly income for housing, it was the housing transportation episode. And I said, anywhere from 25% to 38%, were your mortgage is around 30% of it could be as high as 30%, plus your real estate taxes plus your homeowners insurance plus some maintenance. Now 38 on the high, and that 3638. That's the number they're looking for. So if you've been listening to my podcast, and you listen to that, and you got to try to get your budget percentages, closer to what I talked about, if you've done that you're doing good on if you're looking to refinance, or to buy your first home, you'd be in pretty good shape. So this is from an article that information is from the consumer finance.gov what is debt to income ratio, and why is the 43% income ratio important? That's the article and that's linked to my show notes. And my second article I have is its debt to income ratio. It's from West a pedia.com. And that we're going to go through that now. It's pretty much you know, I've covered a lot of this. So we're gonna go down here to the bottom of the page, or how the computed is to total a monthly debt payments divided by your gross monthly income. To sum up your debt credit and credit cards loans are more each I mean, they go in tell you a little more detail. And I told you a general guideline 43% is the highest debt to income ratio a borrow or can have, and still get qualify for a mortgage. Ideally, the lender prefers a debt to income ratio, lower than 36%, with no more than 28% of that debt going toward servicing a mortgage or rent payment. So they might take your rent payment in consideration, but some lenders may some lenders may not. But if they I don't think they should. It's not debt, monthly rent is not debt, you know, if you're paying 1500 dollars a month for rent, and you're applying for a home, in the mortgage payments going to be 1,200 dollars, with taxes and insurance and I don't think you'll have any trouble no matter what your percentage, because it's going to be lower than what you're already paying. Just a note, they also have a with the credit bureau uses the credit utilization ratio is the percentage of the borrower's total available credit that's currently being your that's what the credit bureaus are using, because they don't know what your gross monthly income would be. So they're looking at how many credit cards you have, what's the maximum total limit of credit you have allowed to you? And how much of that credit Are you using, that more of the credit you're using, the lower your credit score is gonna be, if you're using under 10% of the what your credit limit is, you're gonna be looking pretty good. So for an example, let's say you have a credit card, and you have a $10,000 limit, you can charge up to $10,000. If you only owe $1,000 or less on that credit card, that's less than 10% or less, you're gonna look good, he can go a little over that. But the lower you can keep that number, the better off you're gonna be. And I always thought, well, it's kind of stupid. And they give you this credit, and then they penalize you for using it. That's life. And I've never understood the real reason for that. And the only reason is they're scared that you will default on their on their loan. Limitations debt to income ratio limitation, though important, the debt to income ratio is only one financial ratio. metric using making a credit decision. Well, that's good thing. Your credit history also counts credit score also counts, which we talked about. And the credit score is based on how much credit you're actually using. And then I give an example here. And then, depending on your situation, let's say you have a mortgage or car loan and credit card, a mortgage of $1,000, a car loan of 500, and credit cards of 500, and you have gross income monthly of 6,000. Well, your debt to income ratio is going to be 330 3%. That's good. But how do you lower that down, you want a lower percentage? Well, you can increase your income will lower that percentage, or you can decrease your debt, you could pay off those credit cards$500. If you do that, you'll have a 25%, which is much better than 3333. Bad, but 25 is much better, if you increase your income some and pay off your car loan and your credit card you're gonna have under 20%. So you're going to be in a lot better shape, a real world example of ratios and what's good and what's not good. 35% or less is generally viewed as vailable, and your debt is manageable. He likely have money remaining after paying your monthly bills. 36% to 49% means your debt to income ratio is adequate, but you have room for improvement. Lenders might ask for our other eligibility requirements. So you're borderline 36% to 49%, you're borderline and at 50%. Or Ohio means you have limited money to save or spend as a result, he won't have the money to handle unforeseen event and will have limited borrowing options. And other words you're hurting, you got way too much debt. Now that could have been because you got laid off, or maybe your spouse quit working. And that's what you got if you're married, and you have a spouse, and both of you are working and your say you don't have any children, but you're planning to have children in the future, you got to keep your debt under control. Because if one of the spouses quits working, to stay home and take care of the children, then your debt to income ratio is going to be way out of whack. And you're going to be having a hard time to pay your bills and get by and you're gonna have you know, it's gonna be hard to manage things. So just keep that in mind. So the reason you want to pay off your credit card debt, well, Harry, all right here. Now we know that your lenders use this. What's a good for, it's good for you to know, what percent of your income is already spent every month. And that's a good thing to know. Also, if you figure this on a monthly basis, and it's going down, you know you're making progress on paying off your debt. That's a good thing. And now putting money into your emergency fund is not going to help this ratio, that it's gonna help you over time in case an emergency comes up, or if you get laid off or something happens if your income is reduced, for some reason. Or if an unexpected expense comes along, then you'd be able to handle it with emergency fun and not have to use credit. Remember, the number one step on to reducing your debt is you got to quit creating new debt. This ratio is going to help you see if you're making progress on maintaining your debt at the same level or reducing your debt. If you're like me, your income goes up and down every month every week. I get paid every week, but it could be different every week. It's generally the same every month within a few hundred dollars. But it goes up but now it's not exactly the same. So by using his debt ratio and debt to income ratio, I can see my income went down a little bit and my debt stayed the same. My ratio got a little bit worse and then the next month my income one up, my debt went down, my ratio got a whole lot better. So it's a tool that you can use along with the borrowers your creditors use to determine your ability to make payments. So you know, your debt to income ratio, you know, it's good, you know, your credit rating is good. So you got that in your back pocket. So when you go to get a mortgage, you can get the best rate possible, the best terms possible. And over the life of that mortgage, save hundreds, if not thousands of dollars, in interest and other fees that a lender may require you to pay, you need to have at least 10% down 15% down before getting that mortgage, or you're gonna be stuck paying, I think it's 20%, you pay principal mortgage insurance, which is required by the lender. So if you can have more a larger down payments going to do two things is going to do away with the principal mortgage interest insurance payment, that will not be part of that, it will reduce your monthly payment overall for the life of the loan. Then something else you should consider before buying that first home. Or if you want to buy up whichever the case would be is the order of which you purchase your assets. And the number one item or the biggest ticket item is a home. The second biggest ticket item is a automobile. You want to buy the home first before buying an automobile. Because if you buy an expensive automobile, you get a big loan with it, your debt to income ratios gonna be poor. You might even though you have the income, you might be consider a higher risk for a mortgage. So buy the home first. Once you get in the home a few months and you're comfortable then by that car you may want it's a timing thing. It looks better to the creditor if you do it the correct way. And once you have a home and you build equity in the home over a couple years, buying that car will become easier, not harder. And that's you know, just a note little bit of wisdom there that you should know about. I think it's common sense but not everybody thinks the same way I do so it's better off buy the home first then buy your automobile second. If you need an automobile before you buy the home, try to buy a good used car keep the price down. get by with that you don't have to have your dream car right out of college or when you start your first job. That's the end of another episode. I hope you found it useful. And if you'd like to share this episode with your friends, please do so. I'm open for any suggestions for improvement or for information that you would like to talk about in future episodes. He can go to my Facebook page and leave me a message more than glad to comply. To find my Facebook page go to reduce debt increase wealth.com and click on the Facebook icon to go to my Facebook website.