Debt to income ratio. What the heck? I have an income, I have debt, but what does it mean when I am buying a house?
When buying a house, the mortgage broker will look at your debt against your income. Aside from credit which we went over last week, your DTI is going to play a huge role in not only how much you can borrow but if you can borrow at all. When cleaning up your credit, remember we went over paying down credit cards and outstanding bills. This will lessens the amount of debt you have in relation to your income.
Most mortgage company will look at your DTI and want it to be no more than 43%, you may find lenders with some wiggle room. BUT, in the end you are the one making the payments. You want to keep your DTI as low as possible.
Say you want to pay $1500 a month for your mortgage, you are paying another $300 a month for an auto loan and $200 a month for the rest of your debts, including credit cards and student loans etc. Your monthly debt payments are $2000 when you tally all your monthly payments. This will not include utility, grocery and other items that are not reflected on your credit report. If your gross monthly income is $6000, then your debt-to-income ratio is 33 percent. ($2000 is 33% of $6000.)
This is why you will need to keep your DTI low because even though the bank calculates your DTI as 33%, you still spend $800 on food, $400 on phone bills, $500 on braces, $700 to pay off that medical bill. Your total debt is far higher than what is being reported on your credit report. So you should go in knowing what number you are comfortable at.
You want to stay comfortable, below your means so you are prepared for anything that may just pop up. So even though you may qualify for a lot, buy under that amount as much as possible. If your DTI is busting at the seams, you will need to pay off more debt, give yourself more time to save and drop this number to where it needs to be.
If you have a lower income, do not get discouraged, you may still qualify for a loan. The less debt you have the better your chances are. So if you make only $2000, but your car is paid off, no student loan and you have a $100 monthly credit card payment. You will qualify for a loan. Not $500,000 but depending on your area it will be enough to get you into your starter home.
If you are self employed, note that your income is what you state AFTER deductions. If you report $100,000 for the past two years, BUT, write off $80,000 in expenses for your business, your income that will be used will be only $20,000. Great for taxes, bad for qualifying for a mortgage.
Like I said before, it can be a very confusing an stressful time but it does not have to be. Get your ducks in a row, know before you go. This helps tremendously. So you are working on your credit, improving your DTI, stop by next week for another blog post to keep you going.