When you begin the home financing process, you’ll hear the term debt-to-income ratio frequently. This ratio is a lending tool used to find out how much home a borrower can afford. It looks at a person’s monthly debt obligations and compares then to overall monthly income. Lenders use this tool in order to determine the risk of a borrower. The relationship between risk and ratio is positive; the higher the ratio, the more risk a borrower presents.
No matter what mortgage loan process you are going through, your debt-to-income ratio will always be calculated.
The debt-to-income calculation is more than simple addition. There are many things that go into the final number. Lenders will take into account bonus income, itemized tax deductions, and part-time work. W-2 employees with no bonus income and who make no itemized deductions will require very simple calculations. The majority of people do not fit this mold, however, and overall the process is a complicated one.
Income that is not shown on tax returns or that has not yet been claimed cannot be used for qualification. This means that your ratio will tend to be heavier on the debt side than the income side.
The following will be used to calculate your debt:
- Monthly minimum credit card payments
- Monthly car payments
- Monthly personal loan payments
- Monthly student loan payments
- Monthly child support/alimony payments
If any of these payments are nearing an end, usually within 10 or fewer payments, they will not be included in your debt-to-income ratio. Because of this, it may be of use to you to spend an extra couple months paying off old debts such as car payments or retail purchases before going mortgage or refinance shopping. The less debt you have, the less risk you present, and the lower your mortgage rate will be.