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HOUSING RATIO – WHAT IS IT?
Buying a new home is exciting, but there are plenty of factors that play a role in the approval. One of them is your housing ratio. This is the percentage of your income the lender feels you can allocate towards your home loan. It influences their decision as well as how much money they will approve for your household to borrow.
This is often referred to as the housing expense ratio or the front-end ratio. When you search for a home, a pre-approval is a good idea. It tells you if you can get a loan and how much you can borrow.
It doesn’t make sense to blindly look at homes and hope for the best! Knowing your price range lenders will assist you with making buying a home easier and more practical.
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WHY IS THE HOUSING RATIO IMPORTANT?
This information helps lenders determine your risk. Can you reasonably afford the loan amount monthly on a home you have in mind? In addition to looking at your income, they look at your other expenses.
You may have plenty of money coming in, but if it also goes out quickly to pay other bills that can be a problem.
This calculation is important as it helps lenders see the bigger picture. Are you a risk for them to lend money to? A home loan is a long-term commitment. They don’t want to see you struggle each month to pay that bill.
And they don’t like to foreclose on homes and have to sell them to get some of their money back. They look for low-risk customers to lend funds to for the purchase of a home.
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HOW DO MORTGAGE COMPANIES USE THE HOUSING RATIO FOR LOANS?
When the lender calculates your ratio, they don’t take into account what you currently pay for housing. You won’t pay that any longer once you buy the new home. There are exceptions though such as if you plan to keep the house you live in and buy a second one.
Your income has to be enough to cover both mortgages. If you plan to rent the first home, you can count the rental income as part of your income for the ratio calculations.
Most lenders won’t approve a home loan if the housing ratio is over 28%. There are exceptions though. If your rate is higher than that, you may have to choose a different lender. Since the risk to them is higher, such a loan typically has higher interest.
They may require a larger down payment too. If you have a high credit score, they are more likely to approve your loan, even with a high ratio.
Mortgage lenders often look at the back-end ratio too. This is your DTI (debt to income) ratio. This is a calculation of your overall debts compared to your overall income. For the best outcome, it should be less than 36%.
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Many lenders strive to look at the overall picture of household finances, beyond just these calculations. Some have more flexibility than others.
An underwriter for any mortgage loan has the final say. This is a checks and balances system in place to ensure lenders aren’t giving money to those that can’t afford it.
They don’t want to see consumers with their backs against the wall, with loans they aren’t able to repay.
While you may really want a certain home, spreading your finances too thin can get you into financial trouble in a hurry. Expected expenses or changes in income can create issues you can’t recover from. This is why lenders are very particular about income and debt ratios for home loans.
HOW IS THE RATIO CALCULATED?
To determine the ratio, the monthly mortgage amount is divided by gross monthly income for the household. The mortgage amount includes the actual payment, insurance, and taxes.
If the property is a condo, there can be other fees including Homeowners Association added into that calculation. Monthly utility costs are estimated for the calculations.
There are free calculator tools online you can use to get an idea of your housing ratio. This information will assist you with choices for a home loan. You won’t have any surprises with what the lender finds either.
If your percentage is high, it may be worth it to work on paying down debts or increasing income before you seek a home loan.
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Disclaimer: This article is meant for educational purposes only and is not intended to be construed as financial, tax, legal, or insurance advice.
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