Do You Understand the Impact of Your Debt on Your Home Loan?
The debt ratio is one of the most important things a lender will look at when reviewing a mortgage application. The debt ratio is basically a comparison between the amounts of debt a person has compared with their net income. Luckily, the debt ratio is one of the quicker ways to make adjustments before applying for a loan and is definitely something a potential homebuyer should consider when shopping for mortgage instruments.
While the formulas for determining debt ratio vary with the lender, finding that there is 30% more income than debt is generally desired. The perfect loan candidate wants to only thirty to forty percent of the net income tied up in outstanding debt. A high debt to income ratio means it would be unwise to add a mortgage payment to the list. The debt to income ratio is also used in determining how large a loan the lender will make and the monthly payment.
The basic formula for determining an applicants debt ratio is to take his net income, divide it by three, and then subtract the amount of outstanding debt. For example, if the applicant has a monthly income of $6,000 and no debt, then $2,000 a month is available for monthly mortgage payments ($6,000 3 = $2,000 - $0 debt = $2,000). However, if the same person has outstanding debt of $2,000 then as far as the mortgage lender is concerned there is no money available for a mortgage ($6,000 3 = $2,000 - $2,000 debt = $0). At first glance, having a net income of $6,000 a month and $2,000 in outstanding debt does not seem too bad, but a mortgage lender would view this negatively. (Of course, keep in mind that every lender has unique qualifications.)
Luckily, there is more to determining a persons ability to pay than just the debt to income ratio. Large down payments and equity investments also have an impact on how monthly payments are calculated. If a borrower has retirement plans and significant stock portfolios this will also come to bear on the payment amount and lending decisions. While these two things, among other factors, can mitigate the effect of a higher debt to income ratio, it is still one of the most important factors for mortgage lenders.
The key advantage relating to the importance of the debt ratio to the prospective home buyer is that this is a determinant that can be adjusted before applying for a mortgage. By paying off debt before applying for a mortgage, the potential borrower can significantly improve his chances of getting approved at reasonable terms.
While the formulas for determining debt ratio vary with the lender, finding that there is 30% more income than debt is generally desired. The perfect loan candidate wants to only thirty to forty percent of the net income tied up in outstanding debt. A high debt to income ratio means it would be unwise to add a mortgage payment to the list. The debt to income ratio is also used in determining how large a loan the lender will make and the monthly payment.
The basic formula for determining an applicants debt ratio is to take his net income, divide it by three, and then subtract the amount of outstanding debt. For example, if the applicant has a monthly income of $6,000 and no debt, then $2,000 a month is available for monthly mortgage payments ($6,000 3 = $2,000 - $0 debt = $2,000). However, if the same person has outstanding debt of $2,000 then as far as the mortgage lender is concerned there is no money available for a mortgage ($6,000 3 = $2,000 - $2,000 debt = $0). At first glance, having a net income of $6,000 a month and $2,000 in outstanding debt does not seem too bad, but a mortgage lender would view this negatively. (Of course, keep in mind that every lender has unique qualifications.)
Luckily, there is more to determining a persons ability to pay than just the debt to income ratio. Large down payments and equity investments also have an impact on how monthly payments are calculated. If a borrower has retirement plans and significant stock portfolios this will also come to bear on the payment amount and lending decisions. While these two things, among other factors, can mitigate the effect of a higher debt to income ratio, it is still one of the most important factors for mortgage lenders.
The key advantage relating to the importance of the debt ratio to the prospective home buyer is that this is a determinant that can be adjusted before applying for a mortgage. By paying off debt before applying for a mortgage, the potential borrower can significantly improve his chances of getting approved at reasonable terms.
About the Author:
Wendy Polisi is the founder of Credit Repair College and Finance the Dream. Credit Repair College empowers people to take control of their financial future by learning everything they need to know to repair credit on their own. For more information on credit repair please visit them on the web. Finance the Dream offers rent to own homes throughout the United States.
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