Lower Your Debt Ration for the Best Possible Home Loan

08.09.2009 | Author: Wendy Polisi | Posted in Finance

The debt ratio is one of the most important things a lender will look at when reviewing a mortgage application. The debt ratio is basically a comparison between the amounts of debt a person has compared with their net income. Luckily, the debt ratio is one of the quicker ways to make adjustments before applying for a loan and is definitely something a potential homebuyer should consider when shopping for mortgage instruments.

While different lenders have different precise formulas for determining an applicants debt ratio, the general rule is that the lender wants the applicant to have about 30% more net income than his total debt and expenses. Ideally, the applicant wants to have his outstanding debt at between thirty and forty percent of his income. If the applicant has more debt to service than income available, adding a mortgage payment to the mix is not a good idea. The debt ratio is also one of the key determinants to how much a lender is willing to loan and what the monthly mortgage payment should be.

The formula for calculating debt ratio is fairly simple: take one third of the net income, and subtract the amount of outstanding debt. So if an applicant has a net income of $6000 and no debt then lenders see that $2000 is available for a mortgage payment ($6,000 3 = $2,000 – $0 debt = $2,000). However, with a net income of $6000 and outstanding debt of $2000 then it is clear to the lender there is no money for a mortgage payment ($6,000 3 = $2,000 – $2,000 debt = $0). It might seem that an income of $6000 a month with only $2000 in outstanding debt is not a problem, but even though each lender has a unique formula this debt to income ratio would not be a positive thing.

The debt ratio is not the only factor taken into account when determining an applicants ability to make mortgage payments or what those payments should be each month. Making a large equity investment, or down payment, usually has a direct bearing on what ones monthly payments will be. The same is true if the borrower has significant semi-liquid assets besides his regular monthly income, such as a large stock portfolio or retirement plan. These and other factors can offset a less than ideal debt ratio. Nevertheless, the applicants debt ratio is one of the key factors that most mortgage lenders will look at.

Adjusting the debt to income ratio before applying for a mortgage is an advantageous step that potential homebuyers can do to put themselves in a better position. A borrower can increase the odds of approval by paying off debt before they apply for a mortgage loan.

Wendy Polisi is the founder of Credit Repair College and Finance the Dream. Credit Repair College empowers people to take control of their financial future by learning everything they need to know to repair credit on their own. For more information on fix credit rating please visit them on the web. Finance the Dream offers rent to own homes throughout the United States.

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