Everything a Homebuyer Needs to Know About Their Debt-to-Income Ratio
When applying for a mortgage, lenders look at several things to determine how big of a risk you are. The bigger risk you pose to a lender, the worse your mortgage terms may be. One of the most important things they will look at while determining your risk is your debt-to-income ratio.
What is your debt-to-income ratio?
The debt-to-income ratio is the amount of debt you're carrying compared to your earnings. This allows the lender to identify whether you will be able to afford mortgage payments. Different lenders have different maximum debt-to-income ratios that they will accept, but a select number of lenders, like CityWorth Mortgage, accept increased debt-to-income ratios as high as 50%.
To figure out your front-end debt-to-income ratio, include all your home loan expenses, which will include your estimated monthly principal, mortgage interest, taxes, and homeowner's insurance payments. Divide this number by your gross monthly income to calculate your front-end debt-to-income ratio. You can estimate your total debt-to-income ratio by adding up all your minimum monthly payment obligations, such as credit card, auto loans, and student loan payments to your housing expense. You will also need to add any other expenses, such as alimony or child support. This final number, once divided by your gross monthly income, should be between 40 and 50 percent. Call CityWorth Mortgage today to speak with a professional who can help you calculate your ratio and determine your mortgage term options.
Improving your debt-to-income ratio
If your debt-to-income ratio is over 50 percent, don't despair just yet. There are many ways that you can get around this issue, such as:
- Excluding soon-to-expire loans - If you have any loans that are going to be paid off within the next 10 months, such as a car loan or a personal loan, you can probably exclude it from your debt-to-income ratio. You'll have to supply proof, such as the loan contract.
- Excluding co-signed loans - You can also exclude loans that you signed on to as a co-signer for someone else that's making the payments. You will most likely be required to provide proof in the form of a year's worth of canceled checks from the person who is paying off the loan.
- Borrow from your 401(k) - If you have a 401(k) that has accumulated a decent amount of money, then you may be allowed to borrow from it without having it count as part of your debt-to-income ratio, depending on your 401(k) terms. You may then be able to use that money to pay off one of your other loans to improve your debt-to-income ratio. Just keep in mind that not all 401(k) plans allow this, and there's a federal limit of $50,000 that you can borrow, which must be paid back within five years.
Your debt-to-income ratio is a key factor in not only qualifying for a home mortgage, but obtaining favorable terms as well. Fortunately, there are a few ways you can lower your debt-to-income ratio to ensure that you qualify. Keep in mind that the debt-to-income ratio is only one of several factors that we consider during the mortgage-qualification process, so call us today to learn your personalized options. Don’t let your fear of debt-to-income ratios stop you from becoming a homeowner!
* Specific loan program availability and requirements may vary. Please get in touch with your mortgage advisor for more information.