Is buying a home on your “to-do” list for this year? Or, have you been postponing your home-buying plans because you’re worried you may have old debts hanging around on your credit report? And what about your current debts? How much can you owe and still qualify for the 30-year fixed rate or 15-year fixed rate mortgage you want?
First, here’s what you need to know about how long old debts can stay on your credit report.
In general, an old, unpaid debt will stay on your credit report for seven years from the date it was reported delinquent. In addition to making sure your credit report is accurate and you’ve addressed any potential unpaid debt records that aren’t yours, you also need to make sure your debt-to-income ratio is as good as possible.
What is my debt-to-income ratio, and how is it calculated?
Lenders calculate two debt-to-income ratios when determining how much you can borrow for a home loan. The first type of debt-to-income ratio or DTI adds your mortgage payment, homeowners’ association fees, and mortgage insurance together, then divides them by your monthly income.
For example, if your house payment was $1,000 a month and you paid $200 a month in mortgage insurance, and your monthly gross income was $4,400 a month, your front-end DTI would be 27%.
The second type of DTI is the “back-end” DTI. This ratio adds your housing costs to your monthly revolving debt payments, which can include car loans, student loans, credit card payments, and alimony or child support. So, for example, if you had the above $1,200 housing costs, plus an additional $800 in debt payments between your car and student loans, your “back-end” DTI would be $2,000 divided by your income of $4,400 or 45%.
What are the “ideal” and maximum DTIs to be approved for a loan?
Have you heard of the “28/36” rule? Ideally, your front-end DTI for housing costs shouldn’t be more than 28%. Your back-end DTI shouldn’t exceed 36%. While there are some exceptions, the second DTI example we provided of 45% is higher than the maximum DTI for the majority of lenders, although you may be able to find some specialized lenders up to 50% DTI.
In general, the lower your DTI ratios for both front-end and back-end, the better your opportunities will be for a home mortgage. And, you can get on top of your credit and ensure you have no old derogatory reports that could be holding you back.