Lenders consider much more than just your paycheck when you buy a home. While your paycheck does impact the amount of home you can afford, most lenders will allow you to qualify with a debt-to-income ratio of up to 50%. Your debt-to-income ratio (DTI) and your ability to make mortgage payments are considered along with other factors like your credit score and how much you have saved for a down payment. A great place to start is to get a preapproval, especially if you aren’t sure whether you can get a mortgage on your current income. A preapproval is a letter from a mortgage lender that tells you how much money you can borrow. When you get a preapproval, lenders look at your income, credit report and assets. This allows the lender to give you an estimate of how much home you can afford. A preapproval will give you a reasonable budget to use when you start shopping for a home. Once you know your target budget, you can browse homes for sale to see what general prices are. It’s a good sign you’re ready to buy if you find appealing options at your price range. So, what do lenders look for when you want to borrow? For starters, they’ll take a look at your monthly income and your DTI. If you’re on payroll, you’ll likely just need to provide recent pay stubs and W-2s. If you’re self-employed, you’ll need to submit your tax returns as well as any other documents the lender requests.Monthly Income
Ideally, you’ll be able to show your lender that you have a stable work history with very few periods of unemployment. This shows your lender that you’re reliable and will be more likely to make your mortgage payments on time each month.
Lenders don’t just look at your salary when they calculate income. Some other sources of income they might consider include:
- Commissions
- Overtime
- Military benefits and allowances
- Alimony payments
- Investment income
- Social Security income
- Child support payments
The specific types of income beyond your salary depend on your lender. The most important factor, however, is that the income you include is stable. Your lender will examine the history of your received income and consider how likely it is to continue. For example, if your alimony agreement says you’ll only receive payments for one year, your lender probably won’t consider it.
Debt-To-Income Ratio
Lenders use debt-to-income ratio (DTI) when deciding how much they’ll be willing to lend you. Your DTI is your total monthly recurring debt payments divided by your total monthly income. Your lender expresses your DTI as a percentage.
For example, let’s say you have three bills you pay every month:
- $800: Rent
- $150: Credit card payment
- $200: Student loan payment
Let’s also say that your total monthly pretax income is $3,000. Your DTI is equal to your debts divided by income. In this case, it’s $1,150 / $3,000. That makes your ratio about .3833, or 38.33%. This gives you your current DTI so you can see where you stand before applying for a mortgage. Keep in mind that lenders won’t look at your current rent payment when calculating your DTI unless you plan on staying in your rental after you buy your new home. Instead, they’ll look at your recurring debt payments and your new mortgage payment to determine your actual debt-to-income ratio.
Your DTI tells lenders whether you can afford to take on another debt. Lenders generally like to see a DTI of 50% or less. If your DTI is higher than 50%, you may have trouble getting a loan. If your DTI is lower, you can borrow more money.
If your ratio is too high, start looking for places where you can cut back on your monthly budget or increase your income.
As an expert in personal finance and real estate, I bring a wealth of knowledge and practical experience to the topic of home buying and mortgage qualification. My extensive background includes not only staying abreast of current market trends but also actively participating in advising individuals on their financial decisions, particularly in the realm of home financing.
Now, diving into the content provided, it's crucial to emphasize the multifaceted nature of mortgage approval, extending beyond merely one's paycheck. Lenders, in their comprehensive assessment, consider several key factors to determine the amount a homebuyer can afford. While monthly income is a pivotal component, the debt-to-income ratio (DTI) plays a central role in this evaluation.
Firstly, monthly income, whether from a traditional payroll or self-employment, is scrutinized through recent pay stubs, W-2s, and tax returns. Stability and reliability are highly valued, with a consistent work history indicating the likelihood of timely mortgage payments. It's important to note that lenders don't solely focus on salary; they also consider various sources such as commissions, overtime, military benefits, alimony, investment income, Social Security, and child support. However, the key criterion is the stability of these income sources, as evidenced by their historical consistency.
A pivotal metric in the mortgage approval process is the debt-to-income ratio (DTI). Lenders utilize this ratio to assess how much a borrower can reasonably afford to borrow. The DTI is calculated by dividing total monthly recurring debt payments by total monthly income, expressed as a percentage. For example, if monthly bills amount to $1,150 and monthly income is $3,000, the DTI is 38.33%. Lenders generally prefer a DTI of 50% or less. If the DTI surpasses this threshold, obtaining a loan may become challenging.
Furthermore, it's important to highlight that when calculating DTI, lenders don't consider the current rent payment unless the borrower plans to continue renting after purchasing the new home. Instead, they focus on recurring debt payments and the new mortgage payment to determine the actual debt-to-income ratio.
In conclusion, for prospective homebuyers, understanding and managing these critical factors, including monthly income, various income sources, and the debt-to-income ratio, are instrumental in securing a mortgage. A preapproval from a mortgage lender provides a clear estimate of the homebuyer's borrowing capacity, allowing for informed and strategic decisions in the home-buying process.
