Debt to Income Ratio

You want a large house and a beautiful garden. The problem is in the cost of ownership. You must borrow money from the banker to buy a house. You also need to borrow money for funding college education, buying a car, buying the furniture, and so on.How much debt is too much debt?You do not want to drown in debt. Many bankers the debt to income of 35%. The next question is whether to use pre-tax income or after-tax income?For the sake of conservatism, you may want to base on after-tax earnings. Why?For example, Peter is a bachelor with an annual gross of $100,000. His after-tax annual earningsis $84,000.Based on his pre-tax income of $100,000, Peter can accept monthly repayment of (100,000 x 0.35) divided by 12 months = $2,916Based on his after-tax earnings of $84,000, Peter can manage monthly repayment of (84,000 x 0.35) divided by 12 months = $2,450There is a difference of $466 every month. If Peter saves $466 every month as an emergency fund, he will have a sum of $5,592 every year.Bankers are conservative professionals. They want to see the debt to income ratio less than 35%. That is why it is better to be conservative and use the debt to after-tax income ratio for assessing your long term debt commitments.The best method for reducing debt to income ratio is to pay off all credit card debt. You must not incur credit card debt if you are thinking of buying that big house.