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Debt to Income Ratios and Holiday Spending

  How those Credit Card Bills can put a Hitch in your New Home Purchase

Ah the holidays, when families gather to celebrate, eat, drink and be generally merry.  It’s a wonderful time of year, filled with decorated trees, brightly lit stars and community get-togethers.  It’s also typically a time of gifting, which, for most of us, means navigating the maze of cars waiting for that elusive parking space that is less than a mile walk away from the mall or shopping center, only to be jostled around and by fellow shoppers ignoring all sense of personal space so that they can reach around you to grab the very last “SUPER DUPER FUN EXCITING DOLL” that is all the rage this year.

Before you hit the checkout counter on your “LUXE FASHION MUST HAVE DESIGNER SCARF” this holiday season, if you are considering buying a new home soon, or perhaps in the middle of a purchase transaction, you may want to consider curbing or delaying that large shopping spree.  For most of us, holiday spending equals holiday debt, and that could put the kibosh on your home purchase transaction due to a pesky little financial term known as your debt-to-income ratio.  What is this mystical figure you’ve heard whispered by lenders and been teased about by online blogs (this one included)?  Keep reading to find out everything you never wanted but have always needed to know about DTI and how it impacts more than just your pocket book.

What is DTI

In the most simplest terms, your DTI, or Debt to Income Ratio, is the amount of your total debt obligations, divided by your total income.  If you have a spouse or a co-borrower on a mortgage, both of your total debt and income amounts will be combined to come up with this number.  Your DTI matters because lenders have certain soft (flexible) or hard (not flexible) limits on borrower’s DTI in order to be approved for a mortgage.  The idea is that the DTI gives a fairly reliable insight into whether you will be able to make your mortgage payment long term, and thus whether you are a good or bad risk for lending.

What Counts as Debt or Income

If you busted out the old pen and paper for some quick math and are feeling pretty confident you’re in the safe zone based on your current obligations, you may want to double check those figures before splurging on that new car for the teenager.  For starters, your total debt figures should include your expected new housing payment, including taxes, insurance and any mortgage insurance you may be required to carry.  These numbers may be higher than your current mortgage or monthly rent if you’re upsizing or moving to a more expensive area.  Total debt also includes obligations such as child support, student loans, legal settlements and any negotiated tax payments you may owe the IRS, in addition to the run of the mill credit card and personal and auto loan payments.

When it comes to income, some money you actually bring in may not be able to be counted towards total inflow.  For example, if a significant portion of your income comes from bonuses, commissions or other variable amounts, many lenders require the totals to be consistent over a two year period in order to count towards actual income.  Independent contractors and small business owners face similar problems in showing a consistent amount of monthly earnings, or risk having an entire source discounted from your total income amount.

Don’t Cancel Christmas Just Yet

While all of this may have come off as a dire tale of gloom and doom, don’t turn into Scrooge and cancel the family festivities just yet.  If you are beginning the home searching process, consider using available cash to make purchases instead of credit cards, even if you intend to pay them off at the end of each billing cycle.  This will keep your revolving credit balance, and corresponding DTI, low.  Also, if you are in the middle of transaction, keep in mind that lenders will often run your credit report multiple times throughout the process, some as late as the day before you are set to close on your home.  Buyers wanting to furnish a new home, for example, should consider using cash or holding off until after the transaction has closed to avoid any unnecessary delays in the process.

Debt to Income isn’t a mysterious concept.  Knowing the ins and outs and how it affects not only your credit score but also your entire financial picture with lenders is an important tool in your home buying arsenal.  Know your numbers before you go in, and keep an eye on them throughout the process to make better buying decisions and avoid unnecessary hiccups on your way to owning your dream home.

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