If you are like many home buyers, especially first-time buyers, you may face some unexpected hurdles in securing a loan and working ahead can put you in a better position for success.
One of the biggest issues is narrowing down how much debt you have.
In the finance world it’s known as your debt-to-income ratio (DTI). It’s extremely important to lenders and accounts for nearly a quarter of all denials for loans. If your DTI ratio is too high it suggests that you are reaching beyond your ability to repay the loan.
Here’s a scenario as an example. The buyer has $5,000 a month in qualifying income but also has car loans, credit cards, student loans and other monthly credit obligations that total $1,000. If the mortgage they want costs $2,000 a month in principal, interest, taxes and insurance, the total monthly debt obligations will equal a DTI of 60%. That's way too high for most lenders and not a smart idea for the buyer.
If the buyer’s income is $6,000 a month with monthly obligations of $1000 and they apply for a mortgage requiring lower monthly payments of $1,500, the DTI is 41.6%, an amount under the federal 43 percent eligibility cutoff for a "qualified mortgage."
Fannie Mae and Freddie Mac typically allow a 45% DTI and FHA can stretch the limit a little higher. The lower your overall DTI, the better your chances are of being approved.
Student loans can add up quick making your DTI skyrocket. These loans are problematic because even when they are in deferred status they are usually factored into monthly debt calculations.
Credit issues are the second top killer of mortgage applications. Serious dings on your report due to late payments, collections or other derogatory remarks can decrease your score substantially.
And if you owe a lot on credit cards that’s another big problem. High balances on revolving accounts can bring your score down. If you have a credit card with a limit of $1500 and your balance is $500 your utilization is currently at about 33 percent. You don’t want to go much beyond that because your score could begin to suffer. Absolutely avoid maxing out the card or going over your limit. Each loan program has a minimum credit score requirement and if your score is not at that minimum your loan could be dead in its tracks.
Knowing some of the potential issues before you start can help to alleviate some of the stress that comes with purchasing a new home or refinancing your current one. For friendly, helpful advice on planning this important phase of your life call HomeState Mortgage for free prequalification before you buy.