These numbers can affect your mortgage approval.
When you apply for mortgage loanLenders want to make sure you have good credit risk. This means that they want to know that you will get your loan back on time without any problem during the repayment period.
There are a number of things lenders look to when they are trying to decide if you are going to be a responsible borrower or not. But three key numbers are especially important and they can make or break your loan application:
- Credit rating
- External Debt Income Ratio (DTI)
- Internal DTI Ratio
This is why they are so important.
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1. Credit rating
Your credit rating is a three-digit number that sheds light on your entire history of borrowing.
There are actually several different assessments, including FICO Score and VantageScore… But all credit scoring formulas use the same basic approach. Consider:
- How much of the available credit have you used
- Your payment history
- Have creditors ever sued you
- The types of borrowings you have made
- How many new loans have you applied recently?
After considering all of these criteria, you are assigned a grade for one of three main credit bureaus… This score usually ranges from 300 to 850. Scores below 660 (approximately) are considered bad or fair, and scores above 740 are considered very good or exceptional.
By looking at your credit rating, lenders will quickly understand how you dealt with debt in the past and how you deal with it now. Although one can claim some types mortgage loans with low credit history, it can be more difficult and you have fewer lender options.
2. External DTI coefficient
Lenders also look at another important metric when deciding whether you can afford the mortgage you want: your debt-to-income ratio (DTI).
Your Debt to Income Ratio measures your debt in relation to your income, but in reality there is two different DTI ratios that matter.
Your interface factor is first. It refers to the amount of your monthly gross income that will go towards paying your rent if you qualify for a new mortgage. Housing costs include mortgage payments and homeowner’s taxes and insurance.
For example, if your gross income is $ 5,000 and you want to buy a home that will cost $ 1,800 a month, then your external DTI would be $ 1,800 divided by $ 5,000 or $ 0.36. This is an external DTI of 36%.
In this case, you may find it difficult to find mortgage lenderbecause most people prefer to keep your front end ratio below 28%.
3. Internal DTI coefficient
Your internal ratio is also a method of estimating the amount of financial obligations you would have in relation to your income if you were approved for a mortgage. But this does not only take into account housing costs – all your other debts are also taken into account.
To add to the example above, if you had monthly payments of $ 1,800 for a home, $ 200 for a car loan, and $ 25 for credit cardthen your internal DTI will be the sum of all those monthly payments divided by your gross income of $ 5,000.
Since $ 2025 divided by $ 5,000 equals 0.405, the internal use rate is 40.5%. Most lenders want your IRR to be below 36%. So you may run into borrowing problems again.
Of course, the “majority” is not everything, and there are some lenders that allow you to borrow with a higher debt-to-income ratio as well as a low credit rating. But before moving on, you need to consider both the terms of the loan and whether your decision actually makes sense.
Investing too much of your income in housing costs can put you in a difficult position, especially if you already have a lot of debt. So, if your DTIs are above these recommended thresholds, you can wait to buy a home until you pay off some of your debt. Likewise, if your credit rating is not where you would like, then wait a while to try to increase it, it could potentially pay off in the form of a lower rate and cheaper borrowing costs.
If you are considering buying a house, it is important to understand what these numbers are and why they are so important. This way, you will be able to better assess the likelihood of getting a loan before deciding if you are ready to buy a home.