Your debt ratio determines how much “house” you can afford. If you are going to change your credit score or your debt ratios, change them for the better. You want to owe as little money as possible. The reason is that all of your monthly debts are counted against you. Your lender calculates your debt ratios to determine how much “house” you can afford.
There is a “front end” ratio which is your total housing payment, and then a “back end” ratio which is your housing payment PLUS all your monthly consumer debts. These debts are measured against your monthly income and calculated as a ratio.
For a conventional loan, the front-end ratio is 28% and the back end ratio is 36%. However, with compensating factors the ratios can be approved at higher rate. For FHA loans, the ratios are generally 38% and 43%, and again, with compensating factors the rates can be slightly higher.
For example, if your family household income is $5,000 per month and you are applying for an FHA loan, then a front-end ratio of 38% would be $1,900 maximum monthly housing payment. That includes your mortgage payment, taxes, insurance, and any other housing fees such as HOA or PMI. A back end ratio of 43% would mean your total housing payments plus other debts could only be maximum $2,150 per month.
If you subtract a $1,900 housing payment from the maximum debt of $2,150, you only have $250 per month available to pay your car loans, student loans, and all other monthly debts combined. That is not much leeway! This is a great reason why we are teaching you to keep your debt as low as possible.
The ratios applied by your lender will depend on the type of loan you are getting and what banking program or government agency will be guaranteeing the loan. Some ratios are more generous, while others are stricter. Your mortgage lender will be knowledgeable about the different programs and will help you select the best loan program for your situation.
Read more in our book, "Buy Your First Home", http://tinyurl.com/dy2wjx4.
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