Lately, it seems that a lot of home buyers in California are making offers for…
This article is part of a broader series that examines some of the key requirements for buying a house in California. Today, we will talk about a person’s monthly debt obligations, and how they tie into the home buying and mortgage approval process.
Debt Requirements When Buying a Home in California
Having a manageable level of debt is one of the key requirements for buying a house in California. This is true whether you are using a mortgage loan to finance your purchase, or paying cash for a home.
- Mortgage scenario: If you plan to use a mortgage loan to buy a house in California, your monthly recurring debts will partly determine whether or not you get approved. We’ll talk about this in more detail below.
- All-cash scenario: If you’re planning to pay for a home, evaluating your debt situation is more of a “best practice” than an actual requirement. After all, you won’t be working with a mortgage lender in this scenario, so there aren’t any debt-related requirements to buying a home in California. But it’s still important to consider your debt as it relates to your broader financial picture.
For the rest of this article, we will be talking about the first scenario above. Most people who buy a house in California use a mortgage loan to help finance their purchases. And in these scenarios, debt is one of the more important requirements to buying a house. So let’s explore that angle…
Mortgage Loan Considerations
There are many different requirements when it comes to qualifying for a mortgage loan. But most of them revolve around one thing — your ability to repay the loan.
Your current debt situation is one of the factors that can determine your “ability to repay.” This makes it one of the key requirements to buying a house in California.
When you apply for a home loan, your mortgage lender will review your financial situation to make sure you have the ability to cover your monthly payments. But for most of us, a monthly mortgage payment is just one of several recurring debts. We might also have auto loans, credit cards, student loans, and other forms of debt that require a monthly payment. All of these are considered during the mortgage underwriting approval process.
When it comes to buying a home in California, your debt can affect you in several ways:
1. It determines your ‘DTI ratio.’
Lenders use your recurring monthly debt obligations to calculate something known as the “debt-to-income ratio,” or DTI. It compares the amount of money you earn each month to the amount you pay to cover your recurring expenses.
The DTI ratio can include all of your debts, including the mortgage payment, auto loans, credit cards, etc. Generally speaking, a lower debt-to-income ratio makes it easier to buy a house in California (with a mortgage loan). On the other hand, a DTI ratio north of 50% could make it harder to qualify for financing.
2. It affects your financial ability to repay.
Your total debt load also affects your ability to meet your monthly mortgage payments. This ties into the DTI ratio concept mentioned above. In fact, that’s the whole purpose of that ratio. It helps mortgage lenders determine your ability to repay the loan.
This is true for many types of consumer loans, but especially for mortgages. The bottom line is you have to be able to document a financial ability to pay your monthly mortgage payments, along with all other recurring debts.
Now you can see why debt is one of the important requirements when buying a house in California. It’s part of a broader review process that helps ensure you’re not taking on too much debt, with the addition of a mortgage loan.
Allowances, Exceptions, and Compensating Factors
There is no single rule or requirement regarding debt ratios that covers the entire mortgage industry. Different home loan programs have different requirements and standards, when it comes to the amount of debt you can have.
With that being said, it’s generally best to have a total debt-to-income ratio below 45%. This is not a hard-and-fast requirement for buying a house in California with a mortgage loan. But statistics do show that borrowers who have a ratio above that threshold are more likely to struggle with their monthly mortgage payments.
There are exceptions and allowances for many of the debt-related mortgage requirements.
For example, the Federal Housing Administration (FHA) says that home buyers who use that program should have a total DTI ratio no higher than 43%. But that’s a general rule. Exceptions can be made for borrowers with “compensating factors.” Home buyers with excellent credit, significant cash reserves, and a history of making payments could have a debt ratio up to 50% and still qualify.
Other mortgage programs have similar exceptions and “wiggle room,” when it comes to a borrower’s monthly debt and income situation. So don’t just assume you fall short of the debt-related requirements for a home loan. It’s still worth your while to speak to a mortgage lender. Ultimately, that’s the only way to find out where you stand.
The bottom line: Having a manageable level of monthly debt is one of the key requirements for buying a house in California, at least when a mortgage loan is being used. This is in everyone’s best interest, borrower and lender alike. It’s a common-sense checkpoint that helps ensure you’re not taking on too much debt, with the addition of a home loan.
Have questions? Located in the San Francisco Bay area, Bridgepoint Funding serves borrowers across the entire state of California. We can answer any mortgage-related questions you might have and help you explore your financing options. Please contact our knowledgeable staff for assistance!