About the Debt-to-Income Ratio When Buying A Home
A person's debt-to-income ratio can have a big effect on whether or not they can buy a home. Too much debt can impact a buyer's interest rates and may even be cause for a loan to be denied. Understanding debt-to-income ratio can be important during the home buying process, especially for people who have significant amounts of debt.
Understanding Debt-to-Income Ratio
Debt-to-income ratio is a factor that lenders pay attention to when a loan application is being processed for approval. The ratio consists of two numbers: the amount of money that the potential home buyer owes to lenders every month versus the amount of money that the buyer makes every month. An example of how debt-to-income ratio works: a borrower pays $1,000 per month in debt, and makes $5,000 per month has a 20% debt-to-income ratio. The amount a person makes for the calculation is always before taxes and other deductions, i.e. gross earnings.
The Ideal Debt-To-Income Ratio
Low debt-to-income ratio is better, because home buyers who owe a lot of money to lenders may be at higher risk for default on their mortgage. Lenders like to see credit history, as well as other positive credit indications, so some debt is expected. Low balances on credit cards that are always paid on time, a car loan that is not too high and is also successfully paid every month can be a positive mark in a buyer's favor.
How High Is Too High
When lenders look at debt-to-income ratio, they calculate how much debt the buyer will have after a home is purchased. The limit is set at around 43% debt-to-income ratio, and only around 30% of that debt can be dedicated to the mortgage. If the buyer cannot take out a loan without pushing their debt-to-income ratio over the limit of 43%, then the mortgage application is likely to be declined.
Some lenders will go higher than 43% under certain circumstances. Borrowers who have a high debt-to-income ratio may need to contact many different lenders and explore different types of loans in order to find a loan for which they can qualify.
When the Debts Are Too High
Potential Eagle Hills home buyers who have too much debt to qualify for a home loan will need to make adjustments before they can purchase a house. Many potential buyers solve this problem by paying down debt and lowering monthly payments.
Since the debt-to-income ratio is calculated based on monthly expenses and income, not the overall amount of debt and annual income, all the buyer truly needs to do is lower the monthly payments. Sometimes this can be accomplished by refinancing the loan. Although refinancing may not change the amount of debt actually owed, seeking a lower interest rate and more favorable repayment terms can be very helpful.
Other times, potential buyers solve this problem by increasing their monthly income. For couples where one works and the other doesn't, this can be solved when the unemployed individual gets a job.
No matter what the plan, it's important to work with a lender. Since these options involve making significant changes to personal finances and even lifestyle, working with a lender to ensure that the plan has a chance of working will prevent the buyer from wasting time.
Contact a Lender You Trust
Potential home buyers who aren't sure which lenders are best can start by talking to their bank. Calling various lenders with known reputations in the community can help buyers find the right lender for them.