Debt ratio is a number used by lenders to determine if you qualify for their loan program. Lenders have a wide range of acceptable debt ratio numbers. If your ratio is high, however, you will sometimes have to pay a higher interest rate to get a loan. Because the debt ratio is such an important factor in loan program qualification, you have to be very careful with credit purchases while you are working on buying a home.
For example, let’s say you make $5,000 per month. You have debts of $450 for a car, $300 for credit cards, and $250 for student loans. Your total debt is $1,000. The program you want to qualify for allows a 45% debt ratio. So take $5,000 and multiply it by the 45% debt ratio. The result is $2,250. Then subtract your debt of $1,000. That leaves $1,250 for you to use for a house payment. To find out how much house that is, multiply it by 100. Roughly you can afford a $125,000 home on this program.
Now let’s play with this a little. You lender finds another program which will allow you to have up to a 55% debt ratio. $5,000 times the new ratio of 55% equals $2,750. Subtract the $1,000 in debt and you have $1,750 remaining for a house payment. Multiplied by 100 equals $175,000 home that you can qualify for.
You are really happy with the new program at 55% and go fall in love with a home for $168,000. In the midst of your excitement, you decide to go buy that beautiful bedroom set and dining room piece that you have been watching for so long. The store is having a wonderful special – 18 months no interest. Your paments are only $150 per month. Well, now the lender has to add this to your debt. So instead of subtracting $1,000 from the $2750, they have to subtract $1,150. This results in $1,600 total payment…only a $160,000 house. You have just lost the home of your dreams…
While you are in the process of getting a home – do not buy anything on credit (furniture, a car, new school loan, etc). Even a little purchase can make a big impact on your buying power.
Bryan's Personal Home Buyer Center 