Are you considering buying a house? If yes, your monthly debt obligations play at significant role in your ability to qualify for a mortgage loan. So the next time you are contemplating purchasing a great new car or truck, be aware of the fact the new auto loan payment will reduce your ability to get a mortgage.
Every debt that shows on your personal credit report that has a monthly revolving payment will will be factored into your debt to income ratio.
This means that if you have credit cards that you use on a monthly basis and then pay off in full each month, those minimum monthly payments will be used and your qualifying ability will be reduced.
What happens if the debt is not on a credit report? Like child support or alimony?
Those items will also be factored into your purchasing power because they’re on the tax returns or on bank statements. These items are always located on separation agreements or divorce decrees.
So you’re buying a house, how exactly does debt affect your purchasing power?
It works like this: gross monthly qualifiable income- less any monthly debt obligations like credit cards or other loans etc. multiplied by the maximum debt to income ratio the lender uses. (This varies from loan program to loan program.)
So lets say our fictitious borrower, John has a gross monthly income of $7,500 per month, he also has child support payments of $300 per month. He’s also has a student loan for $80 per month as well as an auto loan which is another $250 per month. All in all, John’s monthly debts before a house payment is even considered is $630 per month.
How much is John’s purchasing power affected by the $630 per month?
Well let’s assume he is going for an FHA loan. FHA loans typically don’t allow debt to income ratios greater than 45% although in some cases that number could be exceeded, read on.
This means in John Borrower’s scenario, the maximum total monthly house payment he can qualify for is $3091.50 per month.
If you’re going to be buying a home make sure to know which loan program will affect your purchasing power the most.
Here are some things to consider:
FHA loans typically have debt income ratio requirements of no larger than 45% of the gross monthly income including all other monthly debts.
USDA Mortgage Loans require the debt to income ratio to not exceed 43% of the gross monthly income considering other debt obligations.
Conventional Home Mortgages usually require the debt to income ratio no bigger than 45% of the gross monthly income.
Sometimes these numbers can deviate based upon compensating factors.
Compensating factors are little plus signs lenders give you to offset standard underwriting. In qualifying for a house lenders are looking for full credit package which includes proof of income, proof of assets and a healthy credit score.
If the credit score is higher, say 740 better, sometimes the lender will allow a higher debt to income ratio. If there is a bigger down payment, that is another sign of a good compensating factor to provide loan qualifying flexibility.
When buying a house it’s all about the housing/debt ratios.
In order of priority here is the way of mortgage lenders look at a file:
1. Housing/debt ratios
2. Credit score
3. Assets (if needed for down payment)
While the debt to income ratio is important, lenders also look at the housing ratio, sometimes called the front end ratio. This is the total house payment divided by the borrower’s gross monthly income. If we go back to John borrower’s example his housing ratio is 41% which is a little high, however if John borrower has an 800 credit score the file will be approved for financing.
Let’s take a look at what unsecured debt does to a home purchase price:
$250 per month-reduces the purchase price by $50,000
$500 per month-reduces the purchase price by $100,000
$1000 per month-reduces the purchase price by $150,000, sometimes more.
Here are three different solutions plus a bonus tip to solve the negative affect monthly debts have on purchasing power.
1. Get more income
2. Reduce your purchase price
3. Eliminate monthly debts
Bonus Tip: Refinance monthly debts
Okay getting more income might be kind of difficult unless you get a raise or there is a co-borrower possibility. Reducing the purchase price is always an option and eliminating monthly debts could also work.
Wait a second? I can refinance monthly debts to qualify for more house? Bingo! You CAN!
You can refinance that auto loan for a lower monthly payment to help qualify for buying a house. If you have a mortgage already on another property same thing, you can refinance the mortgage for a lower monthly payment to help you qualify.
Note: if you presently have an adjustable rate mortgage as you your first or second mortgage on another property the lender is going to have to “gross up” that mortgage to the maximum rate allowed under its note because it’s an adjustable.
Take Heed: if your current first mortgage is an adjustable-rate mortgage, even if the rate is super low, the lender may have to tack on at least another 3% on top of it for qualifying purposes and qualify you with a higher payment because the mortgage is not fixed.
It’s simply a factor of risk based underwriting. If you have a home-equity line of credit in the form of a second mortgage that payment for underwriting purposes will be calculated at 1% of the total line amount divided by 12 which is almost always higher than what the actual payment is.
…….Okay, so far so good, but what about if I’m buying a house and there our monthly debts on my credit report that are not mine?
This can be a double-edged sword. If there are business loans on your personal credit report that are paid for by the business, in the eyes of the credit bureaus, you are responsible for those monthly debts because they’re showing up on your personal credit report.
What if you cosigned for a friend so they could buy a motorcycle. “Their vehicle loan is not mine, but it is showing up on my credit report.”
It it is showing up on your credit report you have a personal obligation to repay that debt and it will be factored into your debt to income ratios and it will affect your purchasing power.
My student loans are deferred and I’m not responsible for paying on them for another four years. “This depends on the loan program you’re going with, on an FHA loan this is correct, on other types of loans such as USDA mortgages, that monthly payment has to be factored in now.”
Buy a house and maximize your purchasing power
What’s a better type of debt to have? A monthly credit card bill or mortgage loan? A home mortgage loan can radically increase your credit score and it’s tax-deductible, a credit card doesn’t keep a roof over your head.
Want to find out how your monthly debts will affect your purchasing power? Start by getting a free mortgage rate quote today. We can go over Homebuying 101: how your monthly debt affects your purchasing power.