Understanding Debt
- 09 March, 2020
For many borrowers, debt can be a scary word. Whether you have racked up high credit card bills, dealt with collection agencies or even had a large loan looming over your head, the mention of debt can make you want to run for the hills. Yet, unless you have a large amount of cash on hand, it is necessary to use when purchasing a home. When it comes to a mortgage, educating yourself about debt will help you make an informed decision. Below is a quick guide to help you understand debt in relation to mortgages.
Debt-To-Income Ratio
When understanding debt as it applies to a mortgage, you need to understand the term DTI (Debt-to-Income) Ratio. This is what helps the underwriter analyze the load of your current monthly debt as it applies to your monthly income. You can work out an idea of your DTI by doing the following:
- Totaling all your monthly debts (these can include credit cards, student loans, other mortgages, car payments and more)
- Dividing your total monthly debt by your monthly income
- Taking the result and multiplying it by 100 get your DTI percentage.
This percentage is your ratio of debt versus income. Lenders prefer to see a DTI ratio when approving you for a mortgage.
The other thing the lender looks at is the types of debts you have. There are 4 total types of debt and each holds different weights when it comes to getting approved.
Types Of Debt
Revolving
Revolving debt will not be a fixed amount every month. Instead, your monthly payment depends on the total amount you have borrowed. Revolving debt will have a total limit that you can borrow up to meaning the amount you pay every month can fluctuate depending on your balance. An example of this is a credit card.
Installment
Installment debt is a lump sum that is paid off over a period of time. This has a fixed monthly payment. You will not be able to borrow any more debt until the loan is paid off completely or is refinanced. An example of this is a car loan.
Unsecured
Unsecured debt comes without any form of collateral. That means that the lender is trusting the borrower to make the payments without guaranteeing repayments. If the borrower was to default on this loan, this would be reported on their credit report. The lender would try to recover the rest of this loan, using a collections agency.
Secured
Opposite of unsecured debt, a secured debt means that there is collateral for the loan. This means that if you defer on the loan, the creditor will take possession of the collateral. An example of this would be a mortgage. In the case that the borrower stops paying on their home, the lender would take ownership of the home and will usually sell the home to recuperate the rest of the loan.
Interested in how your debt affects your ability to buy a home or what your exact DTI ratio is? Click here and schedule an appointment with one of our expert home loan advisors. You will spend an hour going over your debt and putting together a plan to get you into a home. We believe that everyone deserves to be a homeowner.
