In today’s article, I will answer questions I get from readers and students in class regarding loan qualifications.
What is Debt to Income Ratio (DIR) -Low vs High?
How does it apply to getting a mortgage? Low Debt to Income ratio is not a problem for a home buyer, in fact it is what lenders are looking for. It means that your income is high in comparison to your current debt. Debt to Income Ratio is a percentage of your total minimum monthly debt divided by your gross monthly income. High Debt to Income Ratio is the opposite. This is where your debt is higher in comparison to your income. It is calculated the same way. You can get an idea of what your ratio is by doing the calculation (there are also calculators online). However, each lender will take a little different formula of what they include and exclude. Typically, lenders like to see below the 36 percent ratio. The ratio can also affect the interest rate you will pay.
What can be done to lower a DIR?
The calculation takes into consideration all your “recurring debt” for example mortgage payment, rent, car loans, student loans and minimum monthly payments on credit cards. The more of those things that can be paid off the lower your DIR will be. DIR must be kept low when applying for a mortgage. It is not the time to spend credit on a new car or run up your credit cards. This number must stay low until the loan has funded, not just through the application process. I see people who think once approved they are in the clear and immediately run up their credit cards. This is not a good idea. Lenders will recheck this number right up to the closing of the loan and often do.
How can a low credit score be an issue when trying to get a mortgage?
A lender looks at four basic things: Credit Score, Credit report, DIR and proof of Income. A low credit score can keep someone from getting a mortgage, but it can also effect the interest rate and the fees that are charged.
What can be done to improve a credit score so I might qualify for a loan? The easiest thing to do is make sure payments are made on time. There are other things that can be done as well. I created a lesson for Online Trading Academy on what credit (both the score and report) means, what is it made up of and how it can be improved.
What happens if you have a low down payment?
There are low down payment loans offered by Fannie, Freddie and VA and other conventional lenders. The two biggest issues with these loans are 1) PMI (Property Mortgage Insurance) which guarantees your lender will get paid if the loan is defaulted. PMI increases the amount of the payment of the loan which will increase your DIR, so you might qualify for a smaller loan. In a sellers’ market, these kind of loans often make offers less strong. It limits a buyer’s flexibility. 2) The fees that are charged, also increase the loan and payment.
How can this problem be fixed?
The easiest thing is to increase the down payment to 20%. That is often easier said than done; however, the easiest and fastest way is by a gift from a family member. Gifts are allowed, but there is documentation that goes along with them. Perhaps you could also sell something of value and convert the asset to cash to assist with the down payment.
Keep your questions coming.
Diana D. Hill – firstname.lastname@example.org