Why Your Debt to Income Ratio is Key
Your debt to income ratio plays a big role in your ability to afford a home. If you can reduce your debt prior to buying, you can vastly improve your chances of being approved for financing. Buyers today often carry a wide range of consumer debts, from student loans to credit cards to auto loans. What many may not realize is that there are several distinct advantages to focusing on paying down your debts before applying for a mortgage. Here’s a closer look at what you need to know.
Debt to income ratio
One of the factors that a lender will consider when evaluating your mortgage application is your debt to income ratio. In essence, this means they look closely at what percentage of your total income is committed – before and after the proposed mortgage – to paying off debts. It’s considered to be an indication of whether you’re able to afford a specific home or not. Different banks and financial companies have individual “acceptable levels.” It varies depending on a number of factors, including income, what debts you have, and your total financial picture.
Different types of debt to income ratio
Lenders evaluate two potential types of debt to income ratios. The first is the front-end, or what percentage of your income will be dedicated to home expenses in the perceived scenario. Ideally, lenders are looking for a ratio that’s lower than 26 – 30%. The second is called the back-end ratio, and refers to what percentage of your income goes toward all debts including housing, student loans, credit cards, and others. The ideal total here is no more than 35 – 38% of your income. Realistically, a great credit score, significant savings, a larger down payment, and a higher income can all help shift these numbers but what’s above provides a useful guideline.
Tackle your debts to free up capital
Paying off some debts is easier than others. For example, high-interest credit card balances can cost you thousands more than the principle. A car loan may be a payment that’s possible to eliminate. It’s often harder to pay off large student loan balances; potentially, however, buyers could pay down balances and refinance to lower monthly payments. Loan consolidation may help. Paying off your debts not only helps with your lending application. It puts you in a better financial situation overall to afford home ownership, save a larger down payment, and generally weather unexpected expenses and other issues that may arise.
Are you ready to explore whether now is the right time for you to buy? Contact Sydnee Johnson to discuss your financing options and explore how your debt to income ratio may affect your chances of getting a mortgage.