One of the biggest myths for homebuyers is that you can’t have any debt to qualify for a home loan. A variation of this myth is that to get approved you should always pay down your debt. Your BREW Team would like to set the record straight. The amount of debt you have does not automatically disqualify you from being able to buy home.
Lenders view debt through DTI
When it comes to debt, being able to make your payments is the most important thing. When it comes to getting a home loan, your debt-to-income ratio is more important than your total debt if you want to qualify. Debt-to-income ratio, also known as DTI, is the amount of the monthly payments on your debts divided by your gross monthly income.
Here’s an example: if you have monthly debt payments from auto loans, credit card, and other debts totaling $2,000; and you have a monthly gross income of $5,000 (before taxes or withholdings); the DTI is 40%. ($2,000 divided by $5,000 = 40%) Generally, lenders like to see your DTI at 43% or less. However, with other factors like high credit score, large down payment, or large savings and cash reserves, your DTI could go as high as 50% or even 55%.
Important payments to lenders
The kind of debt you have may also be calculated in debt-to-income ratio differently depending on the loan program. These are the main kinds of debt:
Revolving debt is usually a credit card, lines of credit, or other open credit accounts. These accounts are paid down and used again repeatedly. The account balance at the end of each monthly billing cycle determines your payment. For example, the minimum payment on a credit card statement. Each month a new payment is reported on your credit based on the outstanding balance. Your DTI is calculated using the minimum payment on your credit report is calculated in your DTI.
Installment debt is typically a mortgage, car loan, personal loan, or student loan (we’ll address student loans separately). These debts have agreed repayment terms after you borrower a certain amount of money. The payments are set until the debt is paid in full. This payment appears on your credit report and is used in the DTI calculation.
Student loans are a type of installment debt, because money was borrowed a set at specific loan terms. The difference with student loans is that they often do not have a payment if they are in deferment or forbearance. The payments will be 0.5% – 1.0% of the balance on these loans. The percentage varies depending on the loan program. The payment listed on your credit report will be used in your DTI calculation when it is at least 0.5% – 1.0% of the balance. If it is less than that, or if no payment is listed, then 0.5% – 1.0% of the balance is used to calculate your DTI.
Other payments that might be included
Other payments can be included in your DTI. If you are obligated to pay child support or alimony (spousal support), those will also be added. Accounts where you are an authorized, or that you have co-signed for someone else’s debt, will be added as well. (If you can prove that someone else has made these payments for at least twelve months, lenders may be able to exclude them.) Utilities, insurance payments, or other typical monthly bills will not be part of your DTI.
Understanding your debt-to-income ratio can make or break your ability to qualify for a home loan. Your BREW Team powered by Thrive Mortgage can help you create a debt-management strategy to not only get qualified, but also maintain it through closing day and beyond. Our ultimate goal is to help you achieve your short-term and long-term financial goals and Build Real Estate Wealth!
Contact Your BREW Team for a free client consultation to see learn more about getting qualified!