Debt to Income Ratio
The debt-to-income ratio is used by lending institutions to determine whether a person is qualified for a mortgage. It is a way to calculate how much a person’s income goes toward the payment of debt and how much he can afford to spend on monthly housing costs. It shows what percentage of a person’s income is available for a mortgage payment after other obligations are met. The debt-to-income ratio is one important aspect a lender considers before approving a loan.
Credit is what people use to buy products or debt services today and pay for it later. This includes credit cards, utilities, personal loans, or a mortgage. People are charged interest or service charges by the creditor. It is critical that payment is made on time because a credit history will show a borrower’s past debt actions regarding payment pattern - whether he has been faithful in repaying on time or delayed a few times. It does not show whether a person is good or bad, but it shows whether a person is a good or poor credit risk.
The 28/36 Rule
A way for lending institutions to find out if a person is worthy of a loan is by applying the “28/36 rule” to his debt-to-income ratio. The number 28 or 28% refers to the maximum percentage of the monthly gross income that the lender allows for housing expenses. Payments on loan principal and interest, private mortgage insurance, hazard insurance, property taxes, home owner's association dues are all included here. While the number 36 or 36% refers to the maximum percentage of the monthly gross income that the lender allows for housing expenses plus the recurring debt which includes credit card payments, car loans, and other obligations that will take about 6 - 10 months to be paid off. This rule has been used for years because it keeps people out of risky loans and has worked well in the mortgage industry. There are newer mortgage approaches today, but it is riskier on the part of the lender. A better understanding of its terms is needed to avoid losing your home to foreclosure.
Say 'No' to the Lender!
Borrowers should understand that just because lenders tell them they can borrow a certain amount, means they can afford it. The question really is - how much income do you have after paying off all your bills and debt including your housing costs, and how well can you live on it? Lenders are trying to lend as much money as they can despite the debt-to-income ratio. But the only one who can answer that question is you. You are the only one who can determine what you can really afford.
Remember these keys points when considering a mortgage and how these points relate to the debt-to-income ratio:
1. A bad credit history can ruin your future and too much debt can ruin your chances to qualify for a home mortgage
2. Debt-to-income ratio and credit history are two very important factors that lending institutions look into
3. Make your payments on time and keep your balances low.