In a perfect world, we could walk into a mortgage lender’s office and tell the folks there how much we think we can afford to pay for a home each month and they’d hand over the money to buy the home.
Ah, if only.
In reality, lenders have their own criteria for determining who they’ll lend money to and a system by which they make that decision.
Today we’ll look at how that decision is made so that you better understand what it takes to get a mortgage.
There’s this thing called a “DTI”
It’s a shortened version of “debt-to-income,” expressed as a ratio. All that paperwork you’re asked to submit with your loan application helps the lender determine exactly what yours is.
In other words, they’ll learn how much income you have left after paying your debts every month.
There are two types of DTIs, known as “front-end” and “back-end.”
The front-end ratio, should be no higher than 28 percent of your pre-tax income (31% for FHA-backed loans). Calculate yours:
- Add up your monthly expenses for housing. Examples include rent or mortgage, second mortgage payment, HOA fees and insurance (if not included in your mortgage payment).
- Take the sum of the above and divide it by your gross monthly income.
- Multiply that result by 100.
The back-end DTI ratio lets the lender know how much of your income is spent on debt. This figure should be no more than 36% of your income (43% for FHA loans).
Calculate your back-end ratio:
- Add up all of your monthly bill payments. This includes mortgage or rent payment, credit card minimum payments, student loan payments, personal loan payments, auto loan payments, alimony and child support payments. Don’t include utilities, groceries and other living expenses.
- Divide the sum by your monthly gross income.
- Multiply the result by 100
The lowest acceptable ratio isn’t set in stone, but you’ll most likely struggle to find a lender if yours is well under that number.
The good news is that you can raise your DTI by paying off debt or bringing in additional income.
How’s your credit score?
The amount of money you can borrow is based primarily on how risky it is to lend to you. The lender can glean this information from your credit score.
The dreaded FICO score – it has a lot to do with not only how much you can borrow for a house but for a car, a consumer loan and even has an impact on how much you will pay for insurance.
If your credit score is too low (typically below 580) you may not even qualify for even a government-insured loan. Borrowers with the best scores, 740 or higher, not only qualify more easily for a mortgage but get better interest rates as well.
We aren’t mortgage professionals but we’re happy to connect you with a trusted pro to answer any additional questions you may have. Feel free to reach out!