When applying for a mortgage, lenders often consider your debt-to-income ratio when assessing whether you can financially sustain the payments on a new home loan. This number indicates how much of your pretax income goes toward monthly recurring obligations like credit card bills, auto loans and student loans, versus housing expenses.
The debt-to-income ratio is calculated by dividing all debt payments (such as credit cards, auto loans and monthly mortgage payments) by your gross income, which is the amount earned each month before taxes and deductions. According to Brendan McKay, owner and senior loan officer at McKay Mortgage Co. in Bethesda, Maryland, this metric gives mortgage lenders a better insight into your financial situation and helps them decide how much you can afford to borrow.
According to the Consumer Financial Protection Bureau, debt-to-income ratio (DTI) is not a credit score but can affect your ability to get a mortgage and how much interest you’ll pay. NerdWallet reported that in 2020 a high DTI ratio was the leading cause of mortgage denials.
Calculating your debt-to-income ratio (DTI) is a straightforward process that will give you an estimate of how much money you have left to spend each month on housing and other recurring costs. All that’s required to get started are your debt and income documentation.
First, total up all your recurring debt and expenses such as credit cards, car loans, student loans, child support or any other debt reported on your credit report. Then divide the sum of these debts by your gross income to get a percentage.
Michael Cavanaugh, director of residential lending for Citizens Bank in Atlanta, suggests that if you have a lot of revolving debt such as credit cards and your debt-to-income ratio is too high, try to pay it off quickly. Alternatively, look to increase your income by finding another job or negotiating with your current employer to increase earnings.
Lenders may take into account your debt-to-income ratio when determining if you qualify for a Qualified Mortgage, an alternative type of mortgage designed to protect both parties from potentially risky mortgage lending practices. To be eligible, your DTI must be 43% or lower according to CFPB guidelines.
You can improve your debt-to-income ratio (DTI) by paying off debt and working on improving your credit score. The faster you pay off debts, the lower your DTI will be and the better qualified lenders will view your application.
Once a month, be sure to pay off all recurring debts such as your mortgage and rent, plus any non-revolving expenses like utilities or groceries. Generally, lenders require that your total debt-to-income ratio (DTI) not exceed 36% or lower.
Your debt-to-income ratio (DTI) doesn’t tell the full picture about your finances and should not be used as the sole deciding factor when applying for a mortgage. Your DTI doesn’t take into account recurring expenses like food, healthcare insurance and taxes; thus, if you want to purchase a home, you must budget beyond what your DTI indicates is “affordable.”
