So you find you have managed to scrimp and save some money for a down payment on a house, have paid off your vehicle, and you also have found you have enough surplus monthly income for a new car payment. If you are in this position, and your vehicle can still manage to incur a few thousand more miles consider holding off on the purchase of a new car. You may ask, “Why is this advisable?” The reason is that most first-time homebuyers, and some veterans, do not know that your new car payment will directly affect your debt-to-income ratio.
Suppose for illustration sake, you had purchased the new car and you contact a loan officer to get pre-qualified for a mortgage loan. You state your desired price and how much you have managed to scrimp and save for the down payment. You provide your income and may even supply pay stubs and W2 forms. The loan officer methodically crunches the numbers (by telephone, in person, or even over the internet). And the loan officer promptly lets you know that you would have qualified for a higher home sales price if you didn't have “that expensive car payment!"
You see, when determining your ability to qualify for a mortgage, in addition to your three-digit credit score a lender looks at what is called your “debt-to-income" ratio. A debt-to-income ratio is the percentage of your gross monthly income (before taxes) that you spend on debt. This will include your monthly housing costs, including principal, interest, taxes, insurance, and homeowner's association fees, if any. It will also include your monthly consumer debt, including credit cards, student loans, installment debt, and of course, car payments. Your debt-to-income ratio is the amount of debt you have in the form of mortgages, car loans, student loans and credit card debt, as compared to your overall income.
You might ask, “Why is this number so important? I make a good income and I'm never late on my monthly payments, well only occasionally. ” What it comes down to is the amount of debt you have to pay on a monthly basis relative to your monthly income. You may bring in a hefty paycheck but have equally hefty debt payments which could be a problem. Or you may make a modest income but have low monthly debt payments. Your ability to qualify for a mortgage loan is unique to your particular financial situation. That's why lenders look at this number just as closely as your FICO score.
To calculate your debt-to-income ratio, add up all of your monthly debt obligations-often called recurring debt-including your mortgage (principal, interest, taxes, and insurance) and home equity loan payments, car loans, student loans, your minimum monthly payments on any credit card debt, and any other recurring loan payments you might have. Do not include expenses such as groceries, utilities and gas. Take this total and divide it by your gross income from all sources. If you want to try your hand at a debt-to-income ratio calculator, go to www.bankrate.com
Let's say you and your spouse together earn $60,000 per year or $5,000 per month. Your total mortgage payment is $1,100 your car loan totals $400, your minimum credit card payments are $150 and your student loans add up to $100. That equals a recurring debt of $1,750 a month. Divide the $1,750 by $5,000 and you'll find your DTI is 35 percent.
In general, you'll want to keep that number below 36 percent-a threshold that loan officers and credit card issuers often use as a factor when they determine how much they're willing to lend you. If you go higher than the above mentioned number, you may be able to qualify for a loan but usually at higher interest rates and therefore higher monthly payments. The higher your DTI number, the riskier it is for lenders to offer you loans-and the more they'll make you pay for them.
Looking back at our example, suppose you earn $5000 a month and you have a car payment of $400. Using an interest rate of 8.0%, you would qualify for a mortgage loan that was approximately $55,000 less than if you did not have that new car payment. Are you seeing the importance of holding off on that new car?
So, if you have not already bought a new car, and your old one can still take a few thousand more miles, try to qualify for the home first which as an appreciating asset will bring you great tax savings, as well as a place to live in. You can forgo that “new car smell” for another time!
For more information on mortgage loans visit http://www.nefcortez.com
Nef Cortez has been a licensed real estate broker and has held various positions in the real estate industry for over 25 years. Visit his website at Chino Hills CA Real Estate for information on foreclosures.