When it comes to buying a West Edmonton home, hopeful owners are often asked to step outside their comfort zone. Maybe they're forced to look in different neighborhoods than they would have originally considered or to settle for a home with a smaller kitchen than they wanted. Beyond these compromises though, there are also complications that will affect the buyer's finances. Learn more about the debt-to-income (DTI) ratio and how lenders use it to decide on potential candidates.
One Number of Many
Buyers are understandably confused when it comes to how lenders assess them. If everyone's focused on the credit score, they may wonder where exactly their DTI fits in. The best way for buyers to think about it is that the lender is going to look at everything in the buyer's financial history, including debt. So even if the buyer constantly pays their bills on time and avoids taking on unnecessary debt, a high DTI ratio can make it more difficult to be approved at favorable terms.
Types of Debt Calculated
Lenders aren't looking at all debt, but they are taking into account the following:
- Credit cards
- Car loans
- Mortgage payments
- Home association fees
- Child support
- Student loans
The lender adds up all official debt and then compares it to the buyer's monthly income. Income can include anything from monthly paychecks to stock dividends to rental income (if the buyer owns another property). Ideally, lenders want to see the debt at 43% or lower. The more disposable income a buyer has, the more likely it is they'll keep up with their mortgage even if they face a major setback (e.g., a losing a job).
Taxes, Expenses, and Emergencies
Even buyers with a stellar DTI will need to take a deeper dive into their finances. Taxes, home insurance, a plumbing fiasco, and utilities are all necessary costs that can quickly destroy the buyer's ability to save. And this isn't even taking into account things like entertainment, groceries, and child-care related expenses. Buyers need to think about how their savings will look if they're constantly trying to keep their heads above water. It can affect everything from short-term stress levels to long-term retirement goals.
How to Relieve the Burden
Some lenders are more forgiving than others when it comes to a high DTI, so shopping around is always recommended. Going through a broker can also potentially open the door to more products than buyers ever would have access to otherwise. But rather than try to find a loophole, buyers should also be looking at clearing out as much debt as possible and avoiding additional debt at all costs. The exception to this rule is for buyers who have a tremendous opportunity to get in on a popular market that they may never have again.
Most Canadians today have a high DTI. So the question isn't necessarily whether a lender will approve the buyer, it's much more whether the creditor will give favorable terms to the buyer. Lenders have responded to drastic DTIs by upping rates for nearly everyone across the board.
The DTI is often used as the tie-breaker for buyers with high credit scores and good jobs. If monthly debt is too high, the lender is going to be understandably nervous about their position. That's why it helps for buyers to consider their finances from a different standpoint before applying.