What are Debt-to-Income Ratios?
How do They Impact Qualifying for a Mortgage?
When it comes to applying for a mortgage, understanding your financial standing is crucial. Lenders assess various factors to determine your eligibility, and one significant aspect they consider is your debt-to-income ratio (DTI). In this blog post, we will explore what DTI ratios are, why they matter, and how they can affect your chances of qualifying for a mortgage.
(NOTE: In this blog post you may see the acronym PITIA referenced. This stands for: Principal, Interest, Taxes, Insurance & Association Dues. It represents your total monthly housing payment.)
What is a Debt-to-Income Ratio?
A debt-to-income ratio (aka DTI) is a financial measurement that compares your monthly debt obligations to your gross monthly income. It provides lenders with insights into your ability to manage additional debt and make timely mortgage payments. This ratio is calculated by dividing your total monthly debt payments by your gross monthly income and multiplying the result by 100.
Mortgage Brokers, like Contemporary Mortgage Services, Inc., use this DTI calculation to determine how much of a monthly PITIA payment a borrower can qualify for and comfortable afford.
Importance of Debt-to-Income Ratios for Mortgage Qualification:
Lenders consider your debt-to-income ratio as a key indicator of your financial stability. It helps them assess the level of risk associated with lending you money for a mortgage. A lower DTI ratio generally indicates a lower risk for lenders, as it suggests that you have a higher capacity to meet your financial obligations. Conversely, a higher DTI ratio indicates a higher level of debt relative to your income, which may raise concerns for lenders.
Acceptable Debt-to-Income Ratios:
The acceptable DTI ratios can vary depending on the type of mortgage and the lender's guidelines. However, in general, most lenders prefer a DTI ratio of 43% or lower. Certain loan programs, such as FHA and VA, typically allow a much higher DTI than Conventional loan programs. However, Conventional loan programs, will also accept a higher DTI, when there are compensating factors (i.e. additional assets left over, good credit history and score, high down payment, etc...)
There are two main types of DTI ratios that lenders consider:
1. Front-End DTI Ratio:
- This ratio measures your housing-related expenses (e.g., mortgage payments, property taxes, insurance) against your gross income.
- Ideally, your front-end DTI ratio should be 28% or lower.
Calculation: Total Monthly Housing Payment (PITIA) / Total Monthly Gross Income = Front-End Ratio
2. Back-End DTI Ratio:
- This ratio includes all your monthly debt obligations, including housing expenses.
- For most lenders, the maximum back-end DTI ratio they accept is around 36%.
Calculation: Total Monthly Housing Payment (PITIA) + Monthly Debt Payments / Total Monthly Gross Income = Back-End Ratio
(Click HERE to see more examples on how these ratios are calculated)
Effectively Managing Your Debt-to-Income Ratio:
If your DTI ratio is higher than desired, there are steps you can take to improve it and increase your chances of qualifying for a mortgage:
Understanding your debt-to-income ratio and its impact on qualifying for a mortgage is essential when pursuing homeownership. Lenders carefully analyze this ratio to evaluate your financial stability and assess the level of risk associated with lending to you. By maintaining a healthy DTI ratio and effectively managing your debts, you can enhance your chances of securing a mortgage and realizing your dream of owning a home.
Contact Us Today to Learn More:
Navigating the mortgage qualification process can be complex, but you don't have to do it alone. As a trusted mortgage broker, we have the expertise and resources to help you understand and improve your debt-to-income ratio. Contact us today to learn more about how we can assist you in finding the right mortgage options tailored to your unique financial situation. Let us guide you towards achieving your homeownership goals.
To learn more about Debt-to-Income ratios and to see example calculations, check out our full webpage on the topic: https://www.contemporarymortgage.com/dti
How Medical Debt Affects Your Credit Score in 2023
Managing medical debt can be a challenging and stressful experience for individuals and families. Not only does it impact your financial well-being, but it can also affect your credit score, making it harder to secure loans or obtain favorable interest rates. However, recent developments in credit reporting practices have brought some positive changes. In this blog post, we will explore how medical debt affects your credit score in 2023 and discuss the significant updates that have occurred to alleviate the burden for many consumers.
1. The Impact of Medical Debt on Credit Scores:
In the past, medical debt had a substantial impact on credit scores, often resulting in lowered scores and reduced access to credit. Delinquent accounts and collections could remain on credit reports for years, hindering individuals' financial prospects. These negative effects were particularly unfair, considering that medical debt is often unexpected and unavoidable.
2. Removal of Paid Medical Collection Debt from Credit Reports:
One significant development that took effect on July 1, 2022, was the removal of paid medical collection debt from U.S. consumer credit reports. Previously, even after paying off medical debts, the collection accounts would remain visible on credit reports, impacting credit scores. This change provides relief for individuals who have successfully settled their medical debts, as it allows them to rebuild their credit profiles without the burden of past collections.
3. Exclusion of Recent Medical Collections from Credit Scoring:
Another crucial modification implemented in 2022 was the exclusion of medical collections less than 12 months old from credit scores. This alteration acknowledges that recent medical debts may not accurately reflect an individual's creditworthiness. By excluding these collections from credit scoring models, individuals can have a fairer chance to demonstrate their financial responsibility, especially when facing temporary medical challenges.
4. Removal of Small Medical Collections:
As of April 11, 2023, the three major credit reporting agencies, Equifax, Experian, and TransUnion, have taken a further step to alleviate the impact of medical debt on credit scores. They have collectively decided to remove all medical collections under $500 from credit reports. This change is estimated to benefit approximately half of those with medical debt on their reports, providing them with an opportunity to rebuild their creditworthiness.
In recent years, significant changes have been made to address the adverse effects of medical debt on credit scores. The removal of paid medical collection debt from credit reports, exclusion of recent medical collections from credit scoring, and the removal of small medical collections under $500 are all positive steps toward a fairer credit reporting system. These changes aim to provide relief to individuals burdened by medical debt and empower them to rebuild their financial standing.
It is essential to stay informed about evolving credit reporting practices and take proactive steps to manage medical debt responsibly. While these changes offer promising improvements, it is still crucial to communicate and negotiate with healthcare providers and billing departments to avoid medical debt in the first place. By staying vigilant and informed, individuals can better navigate the complex landscape of medical debt and protect their credit scores for a brighter financial future.
Contact us today to learn more about the recent updates and how they impact your ability to qualify for a mortgage.
What Factors Affect Mortgage Approval?
Before you look at homes, it’s always a good idea to get pre-approved for a mortgage. This way you know how much you can afford and what your mortgage payment will be. Before you get pre-approved, though, it’s important to know what factors affect mortgage approval.
Here are the top factors:
Your credit score is the first thing lenders look at when deciding if you qualify for a loan.
It doesn’t need to be perfect, but the higher your credit score is, the higher your chances of approval become.
Ideally, you should have a credit score of 700 or higher, but if it’s not, aim for at least a 660 credit score.
Your credit history is just as important as your credit score. It shows lenders how you handle your finances. To increase your chances of mortgage approval, make sure your credit report doesn’t show any:
Payments over 30 days past due
Credit cards with over 30% of the credit line outstanding
Too many inquiries
Your debt-to-income ratio shows lenders how much of your income is spoken for already. This includes the new mortgage you applied for, too.
The higher your DTI is, the lower your chances of approval become. Ideally, your debt-to-income ratio should be 43% or less. You can calculate your DTI by totaling up your monthly debts (car loans, personal loans, student loans, minimum credit card payments, and new mortgage PITI) and divide it by your gross monthly income (income before taxes).
If it’s higher than 43%, see what debts you can pay off to lower your DTI.
Most lenders want to see a 2-year employment history. This means two years at the same job with a stable income. If you changed jobs within the last 2 years, but it was within the same industry and it was to make more money or take a better position, you may still be in good standing.
Try avoiding changing jobs and/or industries leading up to a mortgage application to improve your chances of mortgage approval.
Money for a Down Payment
Most loan programs require a down payment. It doesn’t have to be 20% or even 10%; you can get by with 3% - 3.5% down today, but you’ll need to prove you have the funds. Lenders look at your bank statements to ensure the money belongs to you and that it’s yours to spend.
You’ll also need money for closing costs, which can be 2% - 5% of the loan amount, depending on your lender and the qualifying factors.
It’s not as hard as it seems to get a mortgage approval, but you should take the time to prepare yourself for the application. The better your qualifying factors are when you apply, the higher your chances of approval become. Also, with higher credit scores, lower debt ratios, and enough money saved for a down payment, you could get more attractive terms and interest rates on your mortgage!
Call us today, and we can chat about your financing options: 407-834-3377.