So, how does a lender view negative accounts on your credit report. Yes, your credit score is a huge factor when applying for a home loan, but your debt-to-income (DTI) ratio is just as important. This calculation is where most people get confused when it comes to different types of negative accounts on your credit report.
Calculating your DTI may help you determine how comfortable you are with your current debt, and also decide whether applying for a home loan is the right choice for you. When applying for a mortgage lenders use your DTI to calculate the risk of a certain amount of money borrowed. The Standard FHA Guidelines allow for roughly 43%, but lenders generally seek ratios of no more than 36%.
Debt-To-Income
To calculate your DTI you will add up all your monthly debt payments, from your credit report, and divide them by your gross monthly income. You will need to have a current credit report so you can view all of the items a lender would be looking at to determine your DTI.
Below is an example of payments on your credit report. Expenses like groceries, utilities, gas, and your taxes generally are not included.
Gross Monthly Income - $8,800.00
We will be using a gross monthly income of $8,800.00 for this example.
House Payment - $2,100.00
We are using $2,100.00 a month house payment for this scenario. This number will change based on the price range you are shopping in.
Car Payments - $463.00
Calculate your families total monthly car payments.
Credit Card Payments - $42.00
The lender is looking at the minimum payment required, based on your balances, by all your credit cards. Some credit card issuers calculate the minimum payment as a percentage of your total statement balance, including interest and fees, usually between 1% and 3%. You can find this number on your statement.
Collections - $4,200.00
These are accounts that have been sold to collection companies. Lenders calculate the total amount of collections and then take 5% of the total debt owed. DO NOT calculate medical collections in this number.
Charge-Offs
These are accounts that a creditor has written off as bad debt. Charge-off balances are NOT calculated into your DTI. This is because the debt has been written off and a creditor can no longer collect on these types of accounts. They are accounted for in the total risk assessment, but there are no official guidelines. Of course they do negatively affect your credit score.
Medical Bills
Zero payment for medical collection, disputes are okay 95% of the time on medical. As you know, these do affect your overall credit score.
Let's Do The Math
House Payment - $2,100.00
Car payments - $463.00
Credit Card Minimum Payment - $42.00
Collections - $4,200.00 x 5% = $210.00
Student Loans - $58,000.00 x 1% = $580.00
Total Monthly Debt Obligations = $3,395.00
DTI = Total Of Monthly Debt Payments divided by Gross Monthly Income
Total Monthly Debt Obligations = $3,395.00
Gross Monthly Income - $8,800.00
DTI = 38.6%
The Bottom Line
By this calculation, at a $2,1000.00 a month house payment your DTI is 38.6% I would assume most lenders could work with this, but below 36% is more desirable. These are general guidelines and every lender has a different degree of risk. The above assumptions will get you close to calculating a correct DTI. Approved Credit Resources is not a lender, but have been in the credit restoration business for many years and spoke with our affiliate mortgage lenders.
After going through thousands of credit reports and explaining the home buying process with clients, this topic comes up on a daily basis. Knowledge is key to reaching your personal financial goals and understanding how lenders view your credit report will help adjust the way you view future financial decisions.
