There are many things to know when buying a new home and getting a mortgage. One of those things to consider is the debt-to-income ration when getting a mortgage. The term debt-to-income ration generally refers to how much total debt the prospective owners have in relation to their income. Along with several other financial factors, lenders use this number when determining whether to grant the loan. It helps to have a general understanding of what it means and how buyers can work toward a healthier ratio.
How to Calculate It
Here are the expenses lenders ask for when totaling debt:
- Student loans
- Credit card bills
- Car loans
- Child support
- HOA costs
- Property taxes
While not all of these expenses may be applicable to home buyers, there's still plenty of debt to affect a person's ratio. The total is then compared to the gross income of the potential owners. Income may include monthly wages, stock dividends, or rent from a real estate property. Lenders are hoping for a ratio of 36% or less, though there are some lenders who are willing to accept much higher numbers.
While total debt doesn't include other expenses such as utilities, home insurance, and grocery bills, homeowners are highly encouraged to take this into account before setting their monthly budget.
What Lenders Think
A lender wants to make sure a homeowner can continue paying their mortgage even if they lose their job or suffer a cataclysmic event. The more debt a person has, the more likely they'll fall behind if they can't replace their income quickly enough. This is why having several sources of income can make it easier for lenders to approve a particularly large loan. (A lender is allowed to use DTI to determine their approval, but they can't use it to calculate interest rates.)
Going Beyond Traditional Lending
Those who have a high DTI still have a few options to explore if they want to secure the home of their dreams. The conventional advice is to try to lower the ratio before applying, but not all buyers have the luxury to wait. (Maybe there's a time-sensitive opportunity unlikely to arise again or the home is located in a particularly popular area.)
One solution for those with a score of 43% or more may be to apply for a Qualified Mortgage through a smaller creditor. These creditors may be more flexible with their terms and can work with different types of financial backgrounds. Government programs, such as an FHA loan, are also far more lenient towards buyers who don't meet the minimum requirements. These programs will guarantee a lender's payments, even if the buyer defaults on their mortgage.
Please note that not all programs are available to all buyers. For example, a USDA loan offers notoriously forgiving terms to home buyers, but the loan is only available for homes in neighborhoods that qualify. Typically, USDA loans only apply to rural homes which may not be practical for all buyers.
If the Ridge at Hangman new home buyers have any leeway when it comes to their timeline, it's recommended that buyers lower their DTI whenever possible. This usually just means paying off as much debt as possible as a way to both lower the ratio and improve a person's credit score. A DTI may not be used to calculate a person's individual interest rates, but their credit score will. No matter where a buyer starts though, having a better idea of how a lender views them can make it easier to streamline the buying process.