Car Payment and Debt to Income Ratios
For those folks who are interested in buying a new home, a new car loan can really ruin it for them. You have to realize that even though though you purchase an inexpensive car, it does not matter. What matters is the monthly payment. An average $300.00 monthly automobile payment can reduce $65,000 worth of buying power and affect your current home mortgage rates. If you still qualify with the higher debt to income ratio, it could increase the interest rate are charged because the mortgage lender views the borrower as higher risk. If the current home mortgage rates are 3.5%, that car payment of $300.00 per month can substantially increase your back end ratio which will cost you an mortgage interest rate adjustment.
Car Payment will reduce borrowing power for mortgage
Lets take an example. John Smith makes $40,000 gross income per year and he wants to qualify for a mortgage loan. He has two credit cards and his monthly minimum credit card payments are $200.00 per month for both credit cards. He has stellar credit scores and no prior bankruptcies, collections, foreclosures, or judgments. What is the mortgage amount John Smith qualifieds for ?
Car Payment and Home Purchase
You first need to calculate the monthly income of John Smith and this is calculated by taking gross annual income and dividing it by 12 months so you get a monthly gross income. This number is $3,333.33. The right hand rule for lenders is the 28/36 rule. They want no more than 28% of the gross income to be allocated towards housing expenses which includes principal, interest, taxes, and insurance. This is also known as the front end ratio. The back end ratio is 36%. The back end ratio is the combined total monthly debts which includes housing payments, plus all other monthly minimum payments such as minimum credit card payments, automobile payments, child support payment, student loans, and other monthly installment payments. There are lenders that will extend the back end ratio to as high as 57% on FHA loans and 50% on conventional loans.
Debt to Income Ratios
On a monthly income of $3,333.33, a mortgage borrower can theoretically afford a monthly housing expense of $3,333.33 x 0.28 which yields $933.33 per month. This mortgage payment would include principal, interest, taxes, and insurance. For the back end ratio, his total monthly expenses are $933.33 mortgage + $200.00 credit card payments which would yield $1,133.33. Now the back end ratio is calculated at $1,133.33 divided by his monthly gross income which is $3,333.33 which yields 34% back end ratio which qualifies him without any problem.
Now, lets say that John Smith had an urge of buying a used Ferrari and his monthly car payment was $700.00 which in his opinion he can easily afford because he is single without any dependents. His new back end ratio will be his total monthly debt payment which is $1,833.33 which was the previous monthly debt payments of $1,133.33 plus his new Ferrari payment of $700.00 and dividing it by his monthly gross income of $3,333.33 which yields 55% back end ratio.
A 55% back end ratio will automatically disqualify him for a conventional loan. He might qualify for a FHA loan with some mortgage brokers. I specialize in helping mortgage loan borrowers with prior bad credit and mortgage loan borrowers who have high debt to income ratios. I can help borrowers in Illinois and Florida who have high debt to income ratios and have lenders who can qualify borrowers with debt to income ratios as high as 56%. Make sure you contact a mortgage broker who specializes in bad credit mortgages and high debt to income ratios if you are in this type of situation.
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