I recently became interested in buying a house again. However I have had concerns about whether my debt would prevent me from obtaining a mortgage. What I found out wasn’t great news, but it gave me a solid idea of what I could do to help myself.
Many would-be homeowners hesitate to apply for a mortgage because of fears that their outstanding debts will prevent them from being approved. And who wants to be told no anyway? However, you may be in a better position than you think as we are often our harshest critic when in reality our situations are always as bad as we make them out to be. This is especially true when it comes to buying a home, credit reports, and debt.
Having been in the same position myself, I can say that such questions definitely prevented me from taking those first steps toward owning a home in the past. With the recent downturn in home prices, though, I once again find myself in a position of wanting to buy a home – despite the fact that I have even more debt now than I did last time I was tempted to buy. In my research, I’ve found some fairly interesting answers to how possible it will be for me to succeed in obtaining a mortgage.
Debt-to-Income Ratio – The First Thing to Know
A debt-to-income ratio (or DTI) is what lenders use to determine what sort of risk you represent to them. If you have too much consumer debt, there’s a much better chance that you won’t make good on your commitment to pay off your home. This ratio is quite simply the amount of money you owe each month (excluding food, utilities, insurance payments, etc.) divided by the amount of money you gross each month. So, my gross income is $36,000 a year before taxes or anything taken out for my 401k. Divided by 12 months, it looks like I’m grossing exactly $3,000 a month. Keep track of that number, as we’re going to plug it into two different kinds of DTIs below.
Front Ratio and Back Ratio – What’s the Difference?
Most lenders allow something in the neighborhood of 28 percent of this gross income to go toward housing expenses, and 36 percent for total recurring debt obligations – which include these housing expenses, plus everything else I (wish I didn’t) owe. So, let’s take that $3,000 and multiply it by 0.28. It looks like I can dedicate $840 a month to housing expenses (mortgage principal and interest, mortgage insurance payment, property taxes, homeowners’ insurance, etc.). This is known as a front end ratio.
A back ratio, though, takes into account all of the above plus that nasty debt I was mentioning earlier like car, student loan and credit card payments, and it can total up to 36% of my income. Okay, I make a $175 payment to a student loan every month, have a $239 car payment, and have to shell out $300 in credit card minimums. I guess it’s a good thing I don’t have any alimony payments. So, 36% of my $3,000 a month is $1080. Subtract the debt I already have, and that gives me a whopping $366 a month for a mortgage payment. Yikes. Not what I wanted to hear. See Debt Ratio and Income for more information on debt ratios.
My Debt-to-Income Ratio is Bad. What Can I Do?
- Quite simply, it looks like I need to reduce my debt – or at least my monthly payments – before I can come close to qualifying for a mortgage. One thing I’m considering is getting rid of my car and buying an inexpensive used one outright. This would immediately give me $239 a month toward my mortgage. Another idea is amortizing student loan payments over a longer period of time, but I don’t think I can get that payment too much lower than it is.
- I have also been eyeing another job that pays me more money. I have heard this from other folks before – make more money allows you to more easily qualify for a mortgage. Perhaps this easier said than done for some folks, but I do believe that I could make more money given my education and experience qualifications.
- Something else I’ve come across is the idea of buying a home in an area in which property taxes are low and there are no homeowners’ dues. These are all things that will help, but it looks like I’m still pretty far away from being able to qualify for a mortgage, and I’m going to have to redouble my efforts to save some money and pay off my credit cards before joining the ranks of the happy homeowners. I just hope I can do it before real estate gets hot again!
Care to share your story on how to qualify for a mortgage? If so, please send it EdGAR at please send to EdGAR my home buying story.
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