Understanding Debt-to-Income Ratio When Buying a Home

Posted by Lauren Schneider on Tuesday, December 1st, 2020 at 10:20am.

What a Home Buyer Needs to Know About Debt-to-Income RatioMortgage lenders have numerous considerations when considering an applicant for a mortgage loan product. One major reason for this is that most lenders prefer to mitigate their risk when offering a loan. Home buyers who have the cash to pay for their home outright do not need to be concerned with the debt-to-income ratio, as it generally applies to individuals who require a mortgage loan to purchase a house.

What does a person's amount of income in relation to their current debt have to do with getting approved for a mortgage loan? Can a significant amount of debt make it harder to qualify for a loan? The following information details the impact of debt-to-income ratio on the mortgage approval process.

For informational purposes only. Always consult with a licensed mortgage or home loan professional before proceeding with any real estate transaction.

The Impact of Debt

Debt can make it more difficult to purchase a home. Many people are able to pay their bills, such as those for credit cards or a higher education, while having high household debt. However, lenders do like the financial cushion a lower amount of debt can provide potential borrowers. For a mortgage lender, the ideal borrower has a comparatively low level of debt, making it easier to pay off their mortgage loan in a timely manner.

Calculating Debt-to-Income Ratio

Take all monthly debt payments, then divide that amount by the applicant's gross monthly income or income generated before taxes are applied. The final number amount, multiplied by 100, is considered to be an applicant's debt-to-income (DTI) ratio.

A lender usually has a special number in their head: 43. In their mind, 43 percent is usually as high of a ratio they are willing to take on when it comes to a mortgage loan. Any higher, and a borrower has an increased likelihood of defaulting on a loan.

However, this is a generality. There are cases when larger lenders are willing to approve someone with a higher debt-to-income ratio, but other factors will also come into play. The smaller the lender, the less willing they are usually to take on a higher risk mortgage loan. For a lender to feel comfortable approving a loan, applicants should try to maintain a DTI ratio no higher than 36 percent.

How to Determine Debt

Some people do not have an overall understanding of their current level of debt. In order to get a better idea of one's debt, add together:

  • Loans (such as a car payment)
  • Credit card payments
  • Any other mortgages or rent payments

School loans and child support payments should also be added to monthly debt payments, if they apply.

Those who are on the higher end may want to pay down their debt before applying for a mortgage loan. This may help to improve their DTI ratio and their chances with a lender. Increasing income through a promotion or second job may also help reduce that ratio. Using an online calculator may help with running the numbers.

One Factor: DTI Ratio

The route to approval takes into account many factors, with DTI ratio playing a part in the mix. Those with a poor credit history or recent gaps in employment may also have some trouble with the process. If partners decide to apply for a mortgage loan, lenders will have to review the DTI ratio, credit score, and employment history of both parties. It is always a good idea for applicants to review finances early on, and see how to improve one's DTI ratio and credit score. People who plan in advance of seeing a lender provides them with more time to attain a good DTI ratio.

For informational purposes only. Always consult with a licensed mortgage or home loan professional before proceeding with any real estate transaction.

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