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What to Know About Debt-to-Income Ratio

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When you’re planning to buy a home, you’re likely to apply with a lender to get a mortgage. The mortgage approval process can be somewhat lengthy, and every lender will have its own requirements.

One thing that any lender will, however, look at is your debt-to-income ratio or DTI.

DTI is a measure of personal finance comparing the debt you owe to your total income. It’s not just mortgage lenders who look at DTI—any time you’re seeking financing, this ratio is likely going to be a consideration.

Why is DTI Important to a Lender?

A lender will look at your DTI before extending financing to see how likely it is that you’ll be able to manage the additional payment each month from your mortgage, in addition to the financial obligations you already have. The idea is that when you have a low debt-to-income ratio, there’s a balance between your debt and income.

The lower your percentage, the more likely you’ll be approved for a mortgage.

With a high debt-to-income ratio, it can show a lender you have too much debt compared to your income. Lenders might see this as a reason not to extend any more financing because you might not be able to afford additional obligations.

Calculating Debt-to-Income Ratio

If you’re thinking about buying a home, it’s helpful to go ahead and calculate your DTI so you have a good idea of how you’re going into the lending process. You can add up all of your monthly obligations to start.

These include your student loans, car loans, credit card payments, an existing mortgage if relevant, and child support. Then, you divide these monthly payments you’re responsible for by your gross monthly income. Gross monthly income is how much you make every month before taxes and any other deductions.

Does DTI Affect Your Credit Score?

Your DTI doesn’t directly affect your credit score. The reason is that credit reporting agencies don’t typically know your earnings, so there’s no way for them to have the information to make this calculation.

What a credit reporting agency will look at is your credit utilization ratio. This is also known as your debt-to-credit ratio. This is a comparison between your credit card balances to the total amount of credit available to you.

How Does Your DTI Affect Your Ability to Get a Mortgage?

When you apply for a mortgage, your financial picture is considered, which includes your DTI. Looking at DTI helps a lender figure out whether or not you can afford to buy a house, and if so, how much home you can afford.

Most lenders want to see that you have a debt-to-income ratio of less than 36%. They typically want no more than 28% of said debt to go toward your mortgage.

A lender will usually not want to have a borrower with a ratio of any more than 43%. If your DTI is higher than that, your lender’s probably going to deny your application. Your expenses and debts would be too high as far as they’re concerned, compared to your income.

How Can You Lower your DTI Ratio?

If you want to get a mortgage and need to lower your DTI ratio, you only have two main options. You can reduce your monthly recurring debt, or you can increase your gross monthly income. You can also do both, of course.

The easiest of the two options is to pay off as much debt as you can.

Sometimes, if you have a high DTI ratio, a lender might accept a co-signer. For example, if you apply for an FHA loan, you can have a relative co-sign, and the person doesn’t have to live in the house with you. The co-signer does need to have good credit and income, however.

Overall, if you have a high DTI the best course of action might be stepping back from trying to get a mortgage, sorting out your finances, and then trying again when you’re ready.

Written by Ashley Sutphin for Copyright © 2021 Realty Times All Rights Reserved.