You want to buy a home, but you’ve heard your debt ratio is too high. What does that mean and how can you fix it?
Lenders take a big risk lending you money to buy a home. They loan money for as long as 30 years, with the expectation that you’ll pay every penny back. What if you can’t? If you lose your job, fall ill, or have financial difficulties, you may fall behind or stop making your payments altogether.
Lenders must pay close attention to your debt ratio to prevent this from happening. While they can’t control what happens in your life, they can control who they lend money to, which is why getting out of debt is important.
Getting out of Debt Lowers your Debt-to-Income Ratio
Lenders look at your gross monthly income compared to your monthly debts when qualifying you for a loan. Most lenders want your current debts including the new mortgage to take up no more than 43 – 50% of your income before taxes.
When you get out of debt, you lower your DTI which makes it easier to qualify. A low DTI can make up for ‘other issues’ on your application. For example, if you have a lower credit score, but have a low DTI, lenders may grant an exception since you don’t have a lot of outstanding debt.
Getting out of Debt Increases your Credit Score
Your credit score and debt-to-income ratio are the two most important factors on your mortgage application.
When you pay your debt down, it automatically increases your credit score. Next to payment history (paying your bills on time), your credit utilization rate makes up the largest part of your credit score.
Your credit utilization rate is the comparison of your outstanding debt to your credit line. The credit scoring model rewards those with less than 30 percent of their credit line outstanding. For example, if you have a $3,000 credit line, you should have no more than $1,000 outstanding at one time for the most positive impact on your credit score.
A higher credit score opens up more doors for financing. Conventional loans, for example, require a 660 or higher credit score. If you can raise your score enough, you may be a good candidate for some of the most lucrative financing available today.
Look at the Big Picture
Lenders look at the big picture when qualifying you for a loan. You don’t need ‘perfect’ credit or the ‘perfect’ debt ratio, but each qualifying factor should help offset the others. If you are a decent risk, you’ll be a good candidate for some of the best programs available today.
Do what you can to pay your debts down or completely off whenever possible. The sooner you start before you want to buy a home, the better your chances of getting approved for the best loan programs available today! Let’s chat and see how you can most improve your DTI to secure the loan you need.