One way you can determine how much money you can afford to borrow is to calculate your debt-to-income ratio.
Your debt-to-income ratio is the percentage of your monthly income that goes toward paying your debts. This is a key number lenders use to determine your capacity to borrow additional funds. It's usually a principal component in determining whether a loan application is approved.
The formula is easy:
Add together all of your debt obligations, then divide your total monthly minimum debt payments (including mortgage or rent) by your monthly gross income.
Example: You earn $5,000 each month in gross income, and a yearly bonus nets you $500 a month. Your total monthly income is $5,500.
You pay $200 a month in student loans, $500 in rent, $150 on a car payment, and $150 on your credit cards and other expenses. Your total monthly debt payments are $1,000.
$1,000 (debt) divided by $5,500 (income) = a ratio of 18.2%.
What's an acceptable ratio?
Acceptable ratios vary from lender to lender. The acceptable maximum, including housing costs, is often around 36%.* Generally, the lower the number, the better your chances of obtaining new credit.