The one who holds the money makes the rules.
If the underwriter says your debt ratio is too high, you will be denied. (And be forewarned: the spreadsheet you made showing you can afford it means nothing. The underwriter will not give it a moment’s glance.)
As I mentioned in a previous post, your loan officer can calculate your debt-to-income (DTI) ratio for you. But what if you want to do it yourself? What if you want to double-check the loan officer? Here’s how it’s done.
1) Take your gross income (before taxes and other deductions). Use the highest figure on your W-2 forms. You must have been employed in the same line of work for the last two years in order to count the income. If you have a brand new part-time gig, it won’t count. If you have brand new bonus income, it won’t count.
For self-employed people, use the Adjusted Gross Income near the bottom of page one of your tax returns. Again, you must be self-employed for the last two years. If you have a new business, you cannot count your self-employment, even if it is in the same line of work as your previous W-2 job.
2) Add up your monthly outgo. Use all of the minimum payment obligations that show on your credit report. If you pay your entire credit card bill each month, you do not use that balance in your outgo; instead, use only the minimum payment required.
Do not count expenses that do not show on a credit report such as phone, utilities, cable, gas or bus, or grocery.
Add in the new proposed mortgage payment for the house you want to buy. Include principal, interest, taxes, insurance, and monthly mortgage insurance if putting less than 20% down. (You can use the easy calculator at MortgageHelper.com here.)
3) Divide your total outgo by your gross income. This is your DTI. Most mortgage lenders want to see a max of 38% DTI, but some will go higher if the rest of your application is strong. The highest I’ve seen is 49% DTI with a 800 credit score and significant cash reserves.
For example, if your gross income is $5,000/mo. and your outgo is $3,000/month:
5,000 divided by 3,000 = 60 DTI. That is too high and will be denied.
You would then need to pay down debts and/or choose a less pricey house.
By knowing your price range, you avoid the disappointment of being denied. And again, if it seems too complicated to calculate yourself, all loan officers at mortgage companies and banks are happy to do it for you. They love using their handy HP calculators, so don’t hesitate to ask.
Happy house hunting! It’s a good time to own your own home.
Emily Johnson found the perfect house for her family. Four bedrooms, three baths. The master suite had a garden Jacuzzi tub, just what she needed after a long, hard day of work. There was plenty of street appeal, too. After hours of looking on the Internet, she’d found The One.
Her next step was to contact the real estate agent who was listing the house and ask to see inside.
Emily fell in love.
That evening, she brought her husband out to see the house, and he agreed with her that it was just what they wanted. They asked the real estate agent how they could make an offer. And that’s when everything fell apart.
You see Emily, like so many other house shoppers, had done everything wrong — starting with her initial search.
What Went Wrong?
When you want to buy a house, your first step is not searching the Internet for what you want. Your first step is to find out how much house you can afford. That way, you can tailor your search to what is appropriate and realistic. What’s the point of falling in love with a house that is out of your price range? Why set yourself up for disappointment?
A pre-qual is a quick evaluation by phone. The loan officer will ask you a couple questions about your income, outgo and down payment, then give you an estimate for the loan amount and home price you can qualify for.
No credit check is needed. To make sure your credit report is not pulled without your authorization, do not give out your social security number.
Once you know your true price range, you can cruise the Internet to your heart’s delight. By looking at homes you can afford, you set yourself up for success and avoid heartbreak.