After your credit score, your debt to income ratio is one of the most important things a lender will look at when reviewing your mortgage application. The debt ratio is basically a comparison between the amounts of debt a person has compared with their income.
By paying of debts, you can adjust your debt to income ration quickly. For this reason, you should always calculate your debt ration before you begin shopping for a home loan.
While the formulas for determining debt ratio vary with the lender, finding that there is 30% more income than debt is generally desired. The perfect loan candidate wants to only thirty to forty percent of the net income tied up in outstanding debt. A high debt to income ratio means it would be unwise to add a mortgage payment to the list. The debt to income ratio is also used in determining how large a loan the lender will make and the maximum monthly payment.
The formula for calculating debt ratio is fairly simple: take one third of the net income, and subtract the amount of outstanding debt. So if an applicant has a net income of $6000 and no debt then lenders see that $2000 is available for a mortgage payment ($6,000 3 = $2,000 – $0 debt = $2,000). However, with a net income of $6000 and outstanding debt of $2000 then it is clear to the lender there is no money for a mortgage payment ($6,000 3 = $2,000 – $2,000 debt = $0). It might seem that an income of $6000 a month with only $2000 in outstanding debt is not a problem, but even though each lender has a unique formula this debt to income ratio would not be a positive thing.
When lenders go about determining an applicants ability to pay and how much their payment should be every month they so look at more than just the debt to income ratio. There are certain factors, such as large down payments and equity investments can make a difference in what a monthly payment will work out to.
Semi-liquid assets such as retirement plans and large stock portfolios will also help to mitigate an imperfect debt ratio. However, it is important not to neglect the debt to income ratio because it is such an important part of whether an application is approved.
In today´s economy, even more attention needs to be paid to your debt to income ratio. This is because guidelines have tightened significantly due to the mortgage market crash. While once there were lenders that would accept a debt ratio of 50% or more, this is becoming difficult to find. Additionally, stated income loans have all but disappeared, so eliminating the need for this to be a factor in your mortgage loan application is no longer an option.
Of all the steps in preparing for the mortgage loan application process adjusting the debt to income ratio is one that can be adjusted quickly. Having debts paid off before filling out a mortgage application can greatly improve not only the financial picture but also improve the odds of approval and the terms of the loan.
Wendy Polisi is the founder of Credit Repair College and Finance the Dream. Credit Repair College empowers people to take control of their financial future by learning everything they need to know to repair credit on their own. For more information on credit repair secret please visit them on the web. Finance the Dream offers rent to own homes throughout the United States.
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