Closing on a house, especially your first one, is an exciting experience. While it’s supposed to be treated like an investment opportunity, for many it’s much more than that. Your first home purchase is significant and it will be meanifingful to you for the rest of your life. Every year, thousands of people apply for their first home mortgage and they are approved. It’s an exciting feeling and they begin to make preparations for the property they are about to purchase. These preparations include what’s needed to make the house liveable including needed upgrades, adding new appliances, buying furniture and perhaps adding features that you would want like a swimming pool, extra room or something else.
There’s no harm in planning what you want to do with your house once it’s yours. However, until the papers are actually signed, everyone, including the sellers and lenders do not see the property as yours. You have to actually sign the closing papers before you can start doing anything to the property, as well as spend any money. Think that’s an obvious tip? Well, thousands of people each year make that mistake and within days of closing end up creating a problem because of their income-to-debt ratio.
Understanding The Income-To-Debt Ratio
43%, that’s what the income-to-debt ratio is set at when you are applying for a home loan. That means that when you ask a lender to give you the money needed to purchase a home, they look at what your income is. While people believe that credit scores are the most important part of buying a home, they are actually second most important. It doesn’t matter what your score is, if your income is too low, you will not qualify for a loan at all. Interest rates and credit scores add to what you will pay back for borrowing money. However, the first numbers that are taken into consideration are your income and your current debt.
If you are applying for a loan and the lender says the mortgage will cost you $1,500 a month, they will look at other debt you have like student and car loans, credit card debt and more. This includes anything you are financing like furniture, your appliances and so forth and that all goes towards the debt. If all your debt combines with that mortgage payment to push you past the 43% mark, you will not qualify for the loan.
Why You Shouldn’t Finance Anything Before Closing
Literally each day, a closing will be delayed because someone did not understand the income-to-debt ratio or thought that the deal was done without signing the papers. They start to make purchases, often for their new home, before they’ve closed and that pushes them past the 43% mark. Lenders will not hesitate to notify you and your realtor that you are no longer eligible for the loan as you have past this barrier. In fact, it’s not just purchases that can push you past at the last minute.
In some cases after inspection, the insurance provider may change their agreement and what they are going to charge you to insure the property. Raising the premiums even $50 a month can be enough to push someone past their barrier and make them ineligible for the loan. This is why it’s important to know exactly how much wiggle room you have and make sure that you are minimizing your debt and spending before you close on the house. Once you close you can finance anything you want and order whatever you want for the home. However, the lenders will watch these numbers literally up until the day you are supposed to close to ensure that you have not surpassed that barrier and if you do, they will have no issue with cancelling the agreement.
What You Can Buy
One argument that comes from home buyers is that they usually are maxed out when it comes to cash because of the downpayment and therefore will need to finance things for the property or even use their credit card to pay for the house. This is why it’s important that you are aware of the numbers and where they are exactly. In some cases, it makes more sense to lower your downpayment by $5,000 or more so that you have the funds needed to cover your expenses until the time you close.
This is why many feel that you not pay more than 20% for the downpayment unless you have the funds available and do not have to worry about the income-to-debt ratio. In reality, the 20% mark is all you need to focus on for the downpayment and you should not worry about going higher than that unless you can add another $50,000 or more. Yes, the less you borrow the less you have to pay back with interest. However, if it will not lower your monthly payments enough, then it makes more sense to keep the cash available so that you can avoid adding debt and hurting your ratio.
Talk To Your Realtor
Working with your lender is a smart plan but you should always work with your realtor as well to ensure that you understand the barriers of your finances and how to properly work them. If you have a very high income and low debt, putting more towards the downpayment makes sense. However, if your numbers are too close to make a decision, this is where your realtor can help you make important decisions and give you a property strategy based on the options you have available.
If your numbers are coming in too close for comfort, have a plan on how to minimize your debt or even increase your income with a second job. These numbers have to look their best before you sign but once you’ve signed on the property and taken ownership, all you have to focus on is paying your monthly mortgage. If you can manage your debt and lower it while also improving your credit score, that will lower your monthly payments as well, helping your ratio and giving you more room to work.