How To Save Money For A House
Saving money for a house has been a generational crusade. From baby boomers to millennials, joining or climbing the property ladder with a home purchase is a common financial goal. In recent years, obtaining the necessary funding to enter into homeownership has become less of a challenge; financial institutions have made a number of programs available to help with down payment requirements and lessen historically stringent credit qualifications . However, both banks and private lenders still look closely at certain financial factors, most notably your debt-to-income ratio, before approving you for a new mortgage.
What is Debt-to-Income?
Your ability to obtain an affordable mortgage for an amount high enough to buy a home depends heavily on debt-to-income calculations. Debt-to-income comes in two forms:
- Front-end ratio: also called the housing ratio, the front-end ratio highlights what percentage of your total income would go toward expenses associated with your home (principal and interest payments, taxes, homeowner’s insurance, and HOA dues). For instance, if your income is $4,000 per month and your new mortgage $1,200, your front-end debt-to-income ratio is 30%.
- Back-end ratio: this calculation shows lenders the portion of income needed to cover all your obligations each month, including your mortgage payment, credit card debt, student or auto loans, child support, and other required payments. As an example, if your monthly income is $4,000, and your mortgage, student loans, and credit card debts require a minimum monthly payment of $1,700, your back-end ratio is 42.5%.
Approval of a new mortgage is based heavily on both ratios, but your outstanding debts and required minimum monthly payments play a substantial role in how much of a mortgage lender’s believe you can safely afford. For most lenders, a back-end ratio should be no more than 36% while your front-end ratio should not exceed 28%. As with all things in life, some exceptions exist.
Tips for Lowering your Debt-to-income
Although you may feel as though your income is more than sufficient to cover your monthly mortgage payment, lenders are more apt to approve your loan when your back-end ratio is relatively low. This can be done in a variety of ways, including:
- Pay down your debt: the best way to reduce your back-end ratio is the eliminate required monthly payments. Paying off a credit card balance or an auto loan will raise your debt-to-income ratios significantly, not to mention boost your credit score. This tactic should be your first priority when seeking out a new mortgage. Here are some great ways to eliminate debt:
- Get rid of Car Payments: If you’re paying more than $0.20 per mile, then you’re paying too much for your car. Punch the numbers into this car-cost-calculator, to figure out an affordable car.
- Consolidate or Refinance student loans: reducing your debt-to-income ratio may also be done by lowering your student loan repayment amount. If you have federal loans, you may want to consider an extended repayment plan or one based on your income. These have the potential to reduce your required minimum payment amount, boosting your available cash each month. However, you may end up paying more in interest over the life of your student loans if you maintain a lower repayment plan for a long period of time.
- Bring more cash to the table: increasing your down payment will effectively lower your total mortgage payment, which reduces the calculation of your total debt-to-income. If you’re having trouble saving enough to get your debt-to-income ratios down to an acceptable amount, you may want to look into down payment assistance programs through your state, county, or your lender.
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Working toward reducing your total outstanding debt prior to applying for a mortgage loan is a necessary step toward affordable homeownership. Having a low debt-to-income ratio is a requirement for most lenders, not matter how much you earn each month. To make yourself a good candidate for a new mortgage, focus on paying down your credit card, personal and auto loan debts first, and then consider increasing your down payment amount. As an alternative or supplement, you may also want to shift to a reduced repayment plan for your student loans, even if temporarily.
If these tactics don’t work to reduce your debt-to-income ratios enough, it may be time to consider lowering your purchase price for a new home or enlist the help of a co-borrower. Combined with strategies to lower your debt-to-income ratios, these additional tactics help reduce your risk level as perceived by your lender, making it easier qualify and ultimately receive funding for your next home.