Buying a Home: Calculating Your Debt Ratio

Filed in Buying a Home on Sep.04, 2009

An borrowers debt ratio is one of the primary things that a mortgage lender looks at when deciding whether or not to give a loan approval. This is essentially the ratio of the applicants personal debt to his net income. Debt ratio is also one of the factors that the applicant can change before applying for a mortgage, and as such is something that any potential home buyer should consider

While different lenders have different precise formulas for determining an applicants debt ratio, the general rule is that the lender wants the applicant to have about 30% more net income than his total debt and expenses. Ideally, the applicant wants to have his outstanding debt at between thirty and forty percent of his income. If the applicant has more debt to service than income available, adding a mortgage payment to the mix is not a good idea. The debt ratio is also one of the key determinants to how much a lender is willing to loan and what the monthly mortgage payment should be.

Dividing the applicants net income in thirds, and lowering that number by the amount of outstanding debts determine the basic debt to income ratio. In other words, if the monthly income amount is $9000 and there is no debt then the lender will say that $3000 is available for a mortgage payment ($9000 3=$3000- $0 debt =$3000 available). If the applicant has outstanding debts equaling $3000 then the lender will perceive that there is no money available for a mortgage payment ($9000 3= $3000 – $3000 debt= 0). Having $9000 net income with $3000 in debt might not seem so bad, but a mortgage lender would not view this in a positive light despite the variances in their calculations.

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 too. 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.

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.

Tags: credit, credit repair, credit repair help, debt, debt ratio, education, Finance, Home Equity Loan, mortgage, mortgage qualification, personal finance

Home Mortgage and Refinancing

Refinancing home mortgage, refinance home loan, mortgage loan, home equity loan