WHAT IS DEBT-TO-INCOME
Every time you apply for some type of credit or loan, you are
going to be hit with the phrase 'debt to income ratio'. This
is merely inquiring how much obligatory debt payments you
have in comparison to your total gross income. Lenders will
use this debt-to-income number to determine what type of
risk you are.
What is Back-End Debt-to-Income?
For example, your monthly take home salary is $10,000 and
your monthly debt payments equate to $5,500. Based on these
numbers, your debt-to-income is 55%. This is considered a
very high debt-to-income which means you will likely be
labeled as high risk by lenders. This type of debt-to-income
is known as your back-end debt-to-income.
What is Front-End Debt-to-Income?
Your front-end debt-to-income is a portion of your
back-end debt-to-income. To compute the front-end you will
need to divide your monthly housing obligation by your
monthly income. For renters, you housing obligation is your
rent. Homeowners will need to total their mortgage principal
as well as taxes, interest, insurance as well as any
other costs tied to their mortgage.
Let’s utilize the numbers from above again. Say your monthly
housing obligation is 30% ($1,650) of your total debt
($5,500). In this situation, your front-end debt-to-income
is going to be 16.5% ($10,000/$1,650x100).
Effect of Debt-to-Income on Loan Applications
What your debt-to-income is one of the most influential
factors when it comes to lenders generating loan approval as
well as loan amounts. In addition, your debt-to-income will
also impact the interest rates you receive. If you encompass
a high debt-to-income (typically 30% or higher), achieving
approval may be difficult. And if you do get approved, you
can expect a higher interest rate and overall less favorable
terms. A high debt-to-income shows that you are overloaded
with monthly debt expenses. It is important to note that a
high front-end debt-to-income is especially bad because that
likely means that you are default on loans.
Lenders typically have precise debt-to-income requirements
when approving loans. Private lenders usually will
necessitate a low debt-to-income. However, government backed
FHA loans have less strict requirements.
Your debt-to-income is not the only variable lenders look at
when determining whether or not to grant approval. Your
credit score is another strong factor. In addition, there
are several less influencing markers like age of credit,
length of current employment, amount of aged credit, amount
of new credit, etc. To maximize your credit worthiness, it
is important that you attempt to maintain a low
debt-to-income. Figure out what your debt-to-income is by
using a
Debt-to-Income Calculator.
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