There are two ratios that people tend to worry about: income and debt. Debt is the amount you owe on credit cards, loans, mortgages, etc. Income is the money you bring in from your job or business. The income-to-debt ratio tells you how much of your available money goes to debt payments every month. However, it's not a perfect measure because it doesn't consider other expenses like living and investments. If you'd like to know why banks won't modify your mortgage, you need to clearly understand these two ratios and how they affect your mortgage.
What Is the Income-to-debt Ratio?
As mentioned before, the income-to-debt ratio is simply a way to determine how much of your available income goes toward paying off debt every month. Most experts recommend that you keep this number at 36 percent or less. In other words, for every $36 of available cash that you have each month, only $1 should go toward paying off debt.
Why Is It Important?
While the income-to-debt ratio isn't perfect, it's still a valuable way to track your overall budget and debt management. If your income isn't large enough to cover your basic living expenses, credit card payments, student loans, car payments, and other bills each month (and still put money into savings), there's a problem.
But, even if you're still able to pay off debt, if your income isn't large enough to cover the amount of money that you owe, it means that you have a problem. It would help if you had more income or more debt. Or you need to cut down on one of your expenses to spend less money paying off debt.
How Do Income-to-debt Ratios Affect Your Mortgage?
When you get a mortgage, all of your monthly debts are carried on the mortgage balance. If you have a mortgage worth $300,000, for example, and an income-to-debt ratio of 36 percent, that means your available cash needs to be $180,000 each month to cover debt payments. So, if your income is only $100,000 each month, you have to either cut down on spending or find a way to make more money. Your mortgage lender won't agree to modify your debt if your income-to-debt ratio is low because they assume that you don't have the financial capacity to deal with such changes.
What Can You Do to Improve your Income-to-debt Ratio?
- Cultivate an Emergency Fund
One of the easiest ways to improve your income-to-debt ratio is by saving money for a rainy day. Experts recommend that you have at least three months of living expenses in savings. That way, if something unexpected happens, like a car accident or job loss, you can keep paying off your debts while you wait to find a new job. Make sure that any extra money you have is earmarked for debt repayment rather than spending it.
According to financial advisors, you should aim for a much larger savings account, such as a safe deposit box or a "rainy day" investment fund, to supplement your emergency fund. According to experts, this will allow you to have enough reserve money without worrying about putting it into your emergency fund at the same time.
- Pay Down Debt
If you carry credit card balances or other types of debt on top of your mortgage, try to pay off as much as possible each month. Many online tools make it simple to track your progress and set goals until you're out of debt for good.
- Increase your income
If your income isn't increasing at the same rate as your expenses, that means you may be reducing your available cash each month to pay off debt instead of saving or paying down other types of debt. Cramming more work into one month may be an excellent way to increase your revenue quickly.
- Make More Money From Investments
Many experts recommend diversifying your investments so that they aren't losing value in the event of a job loss or other financial calamity. Then, with more money brought in from debt payoffs and investments, you can get even closer to the 36 percent goal.
Talk to Us
The income-to-debt ratio can help figure out how much debt you can afford on your mortgage. You need to be sure that you have enough money to pay your bills and put money into savings before taking on any more debt. You can talk to your mortgage lender to find a refinance option that best fits your financial abilities. Reach out to us at Prime Mortgage and talk to our agents about how you can efficiently secure a suitable loan.