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Save for Down Payment or Pay Off Debts. Which is More Important and Why?

Residential mortgage lenders use the Debt-to-Income Ratio (DTI) to assess your ability to manage monthly payments. While program guidelines differ, the general rule is the maximum DTI is 45%. This means that when you add up all your monthly debt payments, say for your auto, credit cards, student loans, mortgage, property tax and insurance, and divide this total by your gross monthly income, the income before paying for government tax withholdings and retirement, can’t exceed 45%. The more consumer debts payments you have, the less room there is to make a mortgage payment. Staying below the 45% ratio forces the maximum mortgage payment to go down and reduces the loan amount.

Said differently, for every dollar of debt payments you need $2.22 in income. Most people have little control over increasing their income, but decreasing their debt is somewhat in their control. If you want to increase your loan amount, then you need to reduce the monthly payments you make on other consumer loans, like car payments and credit cards.

Because many loan programs are available offering very low and sometimes no down payment, it is more prudent to use savings to reduce your debts than to save for down payment. This will enable you to qualify for a large enough mortgage to afford the home you seek in a nice neighborhood.

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