Among millennial first-time homebuyers, there’s a lot of talk about down payments. How do I start saving? Do I need to put 20% down? And so on, and so forth.

Don’t get us wrong, your down payment is important. But so is your debt-to-income ratio (DTI), and first-time homebuyers need to start talking about it now (especially if you have student loan debt).

A survey of homebuyers who purchased between July 2016 and June 2017 showed that, 27% of homebuyers carried some amount of student loan debt, with the average being $25,000. And as you’ll learn, it’s something you can’t ignore when applying for a home loan.

Your DTI is a crucial measure that lenders use to determine your ability to take on a mortgage, and it also helps you answer the question, “How much house can I afford to buy?” So as a first-time homebuyer, it’s something you need to know and hold dear.

Here’s a quick primer on debt-to-income ratios

Your debt-to-income ratio is simply your monthly debt obligations divided by your monthly gross income. These obligations can include an estimate of your mortgage payment, student loan payment, auto loan payment, minimum payment on your credit, and sometimes more. Take this example scenario:

  • Projected mortgage payment: $1,000
  • Student loan payment: $250
  • Auto loan payment: $150
  • Minimum credit card payment: $100
  • Total monthly debt obligations = $1,500
  • Total gross monthly income = $4,500

What sort of DTI should you be shooting for?

To calculate your debt-to-income ratio in this case, you’d divide your monthly debt obligations ($1,500) by your gross monthly income ($4,500) to get a DTI of 33%. Keep in mind, since your projected mortgage payment is just an estimate, your number might be slightly different when it’s time to actually buy.

Conventional wisdom says you should aim for a DTI around 30% when buying a home and getting a mortgage. In most cases, federal guidelines place restrictions if it exceeds 43% when you’re applying for a mortgage – but there are some exceptions to that rule, too.

But don’t forget the larger story DTI doesn’t tell

Your debt-to-income calculation doesn’t include any discretionary spending, like going out to eat, entertainment, and other monthly expenses you might have, such as car insurance, for example.

So while your DTI can give you a fair estimate of your monthly home affordability, it’s up to you to fill in those gaps based on your spending habits to see if you really can afford to buy a home.

Here’s a simple exercise you can try to see if you’d be comfortable month-to-month with a mortgage:

1. Calculate your current monthly expenses – Find the average amount you spend each month on everything, including entertainment, insurance payments, rent, and all of your monthly debt obligations.

2. “Test out” your potential mortgage payment – you’ve already calculated your monthly debt obligations and expenses, now add what your monthly mortgage payment could be to the mix. Try this for 2-3 months as a test drive to see if you’re financially comfortable to buy.

You may be able to improve your DTI, too

Seventy-six percent of student loan borrowers said their loans impacted their decision to buy a home. There’s a good chance their debt-to-income ratio had something to do with it.

you may be able to improve your DTI, too

But student loan debt (or any debt for that matter) is far from a death sentence for your dream of homeownership. There are two ways to lower your DTI ratio: Pay off your existing debt, or increase your income.

Won’t be able to accomplish either of these? You may also be able to take on a co-borrower for your home loan to bring your combined DTI down to an acceptable level.

Suffice it to say, sorting out your debt-to-income ratio is an important step to buying a home. Still, it’s one of many that you need to consider. That’s why we’ve put together this guide to help you along: Your Crash Course to First-Time Homebuying.

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