Remember, the debt-to-income (DTI) ratio is something that lenders look at separately from your credit history. The moral of the story here is that too much debt can ruin your chances of qualifying for a home mortgage. That’s because your credit score only reflects your payment history. It’s a measurement of how responsibly you’ve managed your use of credit. But your credit score does not take into account your level of income. That’s why the DTI is treated separately as a critical filter on loan applications. So even if you have a PERFECT payment history, but the mortgage you’ve applied for would cause you to exceed the 36% limit, you’ll still be turned down for the loan by reputable lenders.
The 28/36 rule for debt-to-income ratio is a benchmark that has worked well in the mortgage industry for years. Unfortunately, with the recent boom in real estate prices, lenders have been forced to get more “creative” in their lending practices. Whenever you hear the term “creative” in connection with loans or financing, just substitute “riskier” and you’ll have the true picture. Naturally, the extra risk is shifted to the consumer, not the lender.
Mortgages have changed to accommodate today’s borrower
Mortgages used to be pretty simple to understand: You paid a fixed rate of interest for 30 years, or maybe 15 years. Today, mortgages come in a variety of flavors, such as adjustable-rate, 40-year, interest-only, option-adjustable, or piggyback mortgages, each of which may be structured in a number of ways. Also, several government agencies have made DTI requirements different for mortgages that have been insured by certain government agencies. For example, the maximum DTI for a FHA mortgage is as high as 50%.
The whole idea behind all these newer types of mortgages is to shoehorn people into qualifying for loans based on their debt-to-income ratio. “It’s all about the payment,” seems to be the prevailing view in the mortgage industry. That’s fine if your payment is fixed for 30 years. But what happens to your adjustable rate mortgage if interest rates rise? Your monthly payment will go up, and you might quickly exceed the safety limit of the old 28/36 rule.
These newer mortgage products are fine as long as interest rates don’t climb too far or too fast, and also as long as real estate prices continue to appreciate at a healthy pace. But make sure you understand the worst-case scenario before taking on one of these complicated loans. The 28/36 rule for debt-to-income has been around so long simply because it works to keep people out of risky loans.
Don’t Be Convinced to Accept a Mortgage That You Cannot Afford
In conclusion, make sure you understand exactly how far or how fast your loan payment can increase before accepting one of these newer types of mortgages. If your DTI disqualifies you for a conventional 30-year fixed rate mortgage, then you should think twice before squeezing yourself into an adjustable rate mortgage just to keep the payment manageable.
Instead, think in terms of increasing your initial down payment on the property in order to lower the amount you’ll need to finance. It may take you longer to get into your dream home by using this more conservative approach, but that’s certainly better than losing that dream home to foreclosure because increasing monthly payments have driven your debt-to-income ratio sky-high.