When you apply for mortgages for the first time, you will undoubtedly learn many new financial terms that you previously were not familiar with. One of these terms is the debt to income ratio, and your lender may inform you that your ratio is too high to qualify for a specific loan amount or that it looks great for the loan amount you are requesting. By learning more about what this ratio is, you can take greater control over your loan request.
What is Your Debt to Income Ratio?
Your debt to income ratio is calculated for the purposes of mortgages as well as other loans that you may apply for, and each lender has a different maximum ratio that they are looking for. It is common for the ratio requirement to be 36 percent or less, but there is some flexibility in this based on different loan programs. The ratio is calculated by adding up all of your monthly expenses and dividing this figure by your total gross income. The monthly expenses include only recurring debt payments, such as credit card payments, auto loan payments, alimony and child support and more. It does not include utilities, child care payments and other non-debt payments. Keep in mind that this ratio also includes the new payment on your house, and this includes the principal and interest as well as the mortgage insurance and property taxes.
Why Is the Ratio Important?
Through underwriting your mortgage request, the lender wants to ensure that the property you are buying is affordable for you. Each lender has their recommended ratio requirement that they use to determine your financial health. The higher your debt ratio is, the more challenging it may be for you to make the mortgage payment on time each month. If your ratio is too high, you may be asked to pay off debt and to close some accounts to avoid recharging debt to those accounts. Because the property insurance is factored into the debt to income ratio, it can also be helpful to shop around for a lower insurance premium if your ratio is tight. On the other hand, if your ratio is very low, you may easily consider applying for a larger loan amount. This may be by purchasing a larger house or by making a smaller down payment.
As you can see, your debt to income ratio plays a major role in your mortgage decision. You should speak openly with your loan representative about what your current ratio is as well as what the lender requirement is. This will help you to make more educated decisions about how to proceed with your loan request. For those of you interested in learning more, there are more resources to be found on the WFCU Credit Union website.