Student loan payments, credit card bills and other expenses can take a hefty bite out of your monthly income. The thought of taking on a mortgage payment alongside your existing debt may sound daunting. Your financial liabilities need not scupper your chances of getting a home loan, however. When it comes to mortgages, lenders understand you'll have other debts.
Loan underwriters divide your debt by your income to figure your debt-to-income ratio. This shows prospective lenders how much of your pretax income that you spend on debt payments each month. To determine your debt, lenders check your credit report and use the information your creditors provide to the credit bureaus. Income includes your salary as well as rental income, bonuses and even alimony. Rules about income verification vary among lenders; some institutions won't count hard-to-verify or short-term income sources, such as commission payments or income that you do not report on your taxes.
If you apply for a Federal Housing Administration-backed mortgage, your DTI ratio cannot exceed 43 percent. This means 57 percent of your monthly income must cover state and federal income tax, utility bills, groceries and your other debts. The FHA percentages are quite generous; many lenders impose much tighter ratios. Those hefty sports-car payments could come back to haunt you.
If you work all the overtime hours that your boss allows and are still over the DTI threshold then you could ask a friend or relative to cosign your loan. Explain that the cosigner is taking on a shared responsibility to repay the debt. The lender will scrutinize the cosigners' DTI ratio and credit score, too, so it won't help if your cosigner has lousy credit or a stack of maxed-out credit cards. As with DTI ratios, rules on cosigners vary among lenders and some institutions only accept cosigners who live in, or co-own, the property being financed.
No one likes to receive a rejection letter from a lender, but rules about DTI ratios are designed to help you as much as your prospective creditors. Prior to the market downturn of 2007, many lenders wrote so-called "liar loans" on which they did not do income verification checks. Some prospective homeowners, unable to resist the allure of new homes, jumped on these loan products and took on debts that they could not afford. Your lender's turning down your application could save you from the cost and the embarrassment of foreclosure.