Many factors go into determining your maximum loan amount and the price at which you can realistically buy a home.
And one of the most important variables is going to be your debt to income ratio. That means your gross income, or before-tax income, compared to the minimum payments for monthly debts that you have.
Your debt-to-income ratio is expressed as a percentage and is calculated by dividing total recurring monthly debt by monthly gross income.
There are a few types of debt that impact your debt-to-income ratio including existing mortgages, student loans, payday loans, and auto loans.
In some cases, having a lower debt-to-income ratio can have a bigger impact on your mortgage than having too low a credit score.
Many lenders recommend keeping the debt-to-income ratio below 45% but different programs will have different rules.
About every $10,000 in loans equates to an additional ~$50 in monthly payments. So it’s important to pay attention to your other debts if you’re not qualifying for what you want.
Let’s say for example you have a credit card balance of $3,000 with a minimum payment of $100. That $100 could be an extra ~$20,000 for a home.
Let’s also say you have $10,000 extra set aside for your closing costs and down payment. Instead of putting that $10,000 as an additional down payment, you could use that money to pay off the $3,000 balance on your credit card and eliminate that $100 payment so you have $20,000 more in your allowable sales price.
There are a few ways to improve your debt-to-income ratio if you’re looking to buy a home soon.
First off, you can prioritize paying off loans and credit card accounts. If your lender will not calculate earnings from side jobs as income, you can use the extra money to pay down debt.
Student loan debt is also a factor when calculating debt-to-income ratio and details including the type of loan and whether the payments are current or have been deferred will impact your loan.
So when you’re applying for a mortgage, it’s not just about the mortgage payment but your other debts as well.
And make sure you talk to your lender if perhaps you’re not getting the answers that you’re looking for on what your maximum loan amount could be and you want to know what else you could pay off in order to get the home you want.
If you have any additional questions about starting your home buying process, you can contact me by emailing (rebecca.richardson@wyndhamcapital.com) or finding me on Instagram (@the.mortgage.mentor).