If you can pay cash for your next home, more power to you as you will not have to deal with banks and other mortgage lenders. Unfortunately, the vast majority of us do not find ourselves in this kind of financial position. Instead, before we are loaned any money, we will have to prove to those lenders that we are competent in dealing with our finances. One of the chief ways that lenders determine this ability is with a calculation called the “debt to income ratio.”
First, it is key to understand that lenders may not care if, in the past, you have paid your bills on time, have had a stable income, and boasted a good credit score if they otherwise think that you are skirting financial ruin. In their minds, as they often say, “past performance is not indicative of future results.” In addition to your credit history, they like to take a look at the amount of money going out of your household now versus how much is coming in and that is where the debt to income ratio comes in.
The first question that you will be asked is what your gross monthly income is. Then, you will be asked to itemize such things as credit card payments, auto loan payments, and the like. These are often referred to as housing expenses and recurring debt costs. They DO NOT include your rent or utilities.
Next, the lender will calculate the maximum percentage of your income that they will allow to go towards the mortgage including all associated costs such as mortgage principal and interest, PMI, homeowner’s insurance, property taxes, and HOA fees.
These two numbers comprise the final ratio. To qualify for a conventional mortgage, you need to obtain a ratio of 28/36. Marginally less restrictive are FHA loans, requiring a 29/41 ratio. It is probably easier to understand the whole computation with some practical examples. So here goes:28/36 (Conventional loan)
These examples are only meant as a rough guideline for you to get an idea of where you stand when it comes to the debt to income numbers. Lenders will be a lot more diligent in making you prove your numbers as they will want you to provide them with final paperwork.
We can help simplify the process for you. Did you find a house you want to buy? Are you interested in talking about refinancing your current mortgage? Do you want to buy a home but don’t think you can afford it? We’re here to help answer all your mortgage questions, contact us today.