Debt to Income Ratios
Posted September 7, 2021 in Real Estate Trends
This is one of the key ingredients of pre-approval: the ratio between how much you carry on personal debt and how much you earn. It gives a good indication of how much additional debt you can handle.
What Debt does a Lender Consider?
Your lender will add up your “fixed” monthly expenses, such as car payments, minimum credit card payments, and other regular payments like monthly child support and student loans. Your lender will not consider such bills as car insurance, food, utilities, phones, gas, and other things on which we regularly spend money.
Your lender will look at the remaining income after those “fixed” debts are subtracted from your gross income and consider that you can use up to a certain percentage of that remaining income for a mortgage payment. Your mortgage payment is more than just principal and interest; you have to add in taxes, insurance, and mortgage insurance. It changes based on the loan you are getting approved for. Most FHA loans are about 45% debt to income ratio. This leaves 55% of your income for extra expenses.
First, talk with your lender, as they are always your best source of up-to-date information regarding loans. Your lender will take that potential mortgage payment and apply it to how much that payment is for a loan amount. You are not pre-approved for a loan amount, you are only pre-approved for a monthly payment amount. If interest rates change, so does your loan approval amount. As interest rates go up, the dollar amount of your pre-approval goes down. If taxes on the home are different than what your lender estimated when doing your pre approval, your loan amount can change.
How Much Can You Afford?
Have a budget in place. If you have an idea of how much you are looking at for a mortgage payment, start that payment now. We recommend putting extra money away into a savings account. This will help by letting you know if you can comfortably afford that payment, and give you a bit extra for those things that can come up after you buy your home, like paint, a fridge, washer, and dryer, since most likely those items will not come with your home.