Debt to income ratios and your buying power.
If you are planning to buy a house you will most likely need a mortgage. To get a mortgage you must understand debt, your credit, and your credit scores.
Debt is anything you owe – personal loans, car payments, student loans, a mortgage on a house, a loan you cosigned on, credit card balances, etc. Assets are what you own, a house, a car, furniture, jewelry, stocks, bonds, land, inventory. Lenders look at your debt and your income as well as your assets. They want to determine your net worth as well as your record for managing your bills. Debt is compared to your income to determine your debt /income ratio. If your debt is within certain ranges, you are considered in good financial health and a good prospect for lenders.
Lenders are in business to earn a return on the money they lend; they expect a return of the principal plus interest. Consequently, assessing the likelihood that they will see a return of the money they lend and that they will earn a profit on those transactions is integral to their lending process. Lenders use credit scores and debt to income ratios to help them determine whether an applicant is a good prospect for a loan. Your credit score is used to determine your creditworthiness. A high debt to income ratio poses higher risks to them so they will most likely charge higher interest rates.
If your debt to income ratio is less than 10% you are considered to have excellent credit. A person with excellent credit will very likely enjoy lower interest rates. If your debt to income ratio falls between 10% and 20%, lenders consider you to have good credit and therefore you are a good credit risk – likely to enjoy lower interest rates; if your debt to income ratio is above 20% you have a high debt to income ratio which means that creditors – banks, mortgage lenders – will consider you a higher risk. Consequently, they will charge higher interest rates because they think you are less likely to fulfill the obligation to pay off the loan; you are destined to feel the brunt of higher interest rates and fees.
Your debt to income ratio coupled with your credit history ( your payment history) will determine the amount a lender is willing to fund for a mortgage on your behalf.