A tool that lenders use to qualify buyers for a mortgage is called the debt-to-income ratio and it is an important factor in determining loan approval. It gives the lender an indication of the amount of debt that a potential borrower is obligated to in relation to how much income they have.
To determine total monthly debts, the lender will add normal and recurring monthly debt payments such as monthly housing costs, car payments, minimum credit card payments, personal loan payments, student loans, child support, alimony, and other things.
You arrive at a percentage of the monthly income by dividing the monthly income into the monthly debt. There are two different ratios that lenders look at commonly called the front-end and the back-end.
The proposed total house payment that includes principal, interest, taxes, insurance, mortgage insurance if required, and homeowner association fees are what we call the front-end ratio. Lenders typically do not want these expenses to comprise more than 28 percent of the monthly gross income.
To create the back-end ratio, we must include the front-end ratio items plus other monthly obligations like the ones described earlier. Lender preference is for the ratio to not exceed 36 percent of the monthly gross income, but a few lenders will stretch it to 43 percent. Borrowers who are trying to obtain an FHA mortgage might be allowed a higher back-end ratio.
A proposed house payment should not exceed $2,240 or 28 percent of the monthly gross income if a borrower has $8,000 monthly gross income. Also, their combined house payment and monthly debt should not exceed $2,880 or 36 percent of the monthly gross income.
As an example, let’s say a borrower has $900 in monthly debt. That would only leave $1,980 for the maximum house payment. The monthly debt became a limiting factor that affected the house payment.
Additionally, the debt ratio could affect the interest rate that a buyer will qualify for when determining a mortgage. Good credit and good ratios can result in being approved for a mortgage faster. But if a buyer is on the upper side of the debt ratio range, a lender may just charge a higher interest rate for taking on the risk of a more marginal borrower.
The math is not hard, but it is not exactly a do-it-yourself project. I can have a trusted professional assess your situation and give you an accurate picture of what price home you can afford and what interest rate you can expect to pay.
Getting pre-qualified so you know your numbers before you start looking at homes and more important before you put a contract on one. Know that all lenders are not the same. As stated before, I can recommend a trusted mortgage professional who specializes in your type of mortgage. Download my FREE Buyer’s Guide.
Both things are important to know before you start looking at homes and especially before you contract for one. All lenders are not the same. Call me to get a recommendation of a trusted mortgage professional who specializes in the type of mortgage you want. Download this FREE Buyers Guide.
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