It’s no surprise that when deciding if you’re a qualified candidate for a home loan, lenders want to see that you’re not swimming in debt — which is where your debt-to-income ratio, or DTI, comes in.
What is a debt-to-income ratio?
Simply put, your DTI is all your monthly debt payments divided by your gross monthly income (your pretax monthly income). Monthly debt, often called recurring debt, includes things like car loans, student loans, your minimum monthly payments on any credit card debt, and any other loans you might have, including mortgage and home equity loan payments on other properties.
For example, if you pay $300 a month for a car loan, $500 for a student loan, and $400 a month for your credit card minimum payments, your recurring debt is $1,200. If your gross monthly income is $4,000, then your debt-to-income ratio is 30% ($1,200 is 30% of $4,000).
How does my DTI ratio affect my ability to get a mortgage?
So what does this percentage mean? In the above example, your 30% DTI would indicate you are a qualified loan candidate. According to studies of mortgage loans, the lower a borrower’s DTI, the more likely they are to successfully pay off monthly debt, making them a lower-risk loan candidate. In general, 43% is the highest DTI a borrower can have and get a qualified mortgage. But of course, the lower that percentage is, the better — lenders typically say 36% or below is ideal.
If your DTI percentage is above 43%, don’t panic. You can still get a mortgage, but you may need to work a little harder comparing lenders to find the mortgage that works best for you. For example, a small creditor can offer qualified mortgages even to a borrower whose DTI is over 43%. A creditor is considered “small” if they have less than $2 billion in assets and made no more than 500 mortgages in the year prior. Federal Housing Authority (FHA) and Veterans Affairs (VA) loans allow higher DTI ratios, but you’ll have to pay mortgage insurance (FHA loans) or a loan-guarantee fee (VA loans). A large lender can also offer you a mortgage as long as they’ve made a reasonable, good-faith effort to determine you can repay the loan and have followed specific rules set by the Consumer Financial Protection Bureau.
If you want to lower your DTI ratio, the answer is simple: either increase your monthly gross income (time to ask for that raise at work!) or lower your monthly debt payments (if you can, consider paying off your student loans at a faster rate, for example). This is all easier said than done, but with some forethought and careful planning, you can lower your DTI to the ideal range by the time you’re ready to buy a house.