Homebuying and debt: What you need to know
Your debt-to-income ratio (DTI) helps lenders decide whether to approve your mortgage application. But what is it exactly? Simply put, it is the percentage of your monthly pre-tax income you must spend on your monthly debt payments plus the projected payment on the new home loan.
Generally, the lower your debt-to-income ratio is, the more likely you are to qualify for a mortgage.
How to calculate it
Lenders calculate your debt-to-income ratio by using these steps:
1) Add up the amount you pay each month for debt and recurring financial obligations (such as credit cards, car loans and leases, and student loans). Don’t include your current mortgage or rental payment, or other monthly expenses that aren’t debts (such as phone and electric bills).
2) Add your projected mortgage payment to your debt total from step 1.
3) Divide that total number by your monthly pre-tax income. The resulting percentage is your debt-to-income ratio.
Monthly debt obligation (including current or potential mortgage payments)
Monthly pre-tax income
Most lenders want your debt-to-income ratio to be no more than 36 percent, but some lenders or loan products may require a lower percentage to qualify.
Lowering your debt-to-income ratio
If you find your DTI is too high, consider how you can lower it. You might be able to pay down your credit cards or reduce other monthly debts. Alternatively, increasing the amount of your down payment can lower your projected monthly mortgage payments. Or you may want to consider a less expensive home.
You could also lower your DTI by increasing your income. Some lenders may take into account nontraditional sources of income such as alimony, military or work housing stipends, or a trust income. If you have nontraditional sources of income, be sure to ask your lender about the availability of mortgage products and programs that include them.
In addition to lowering your overall debt, it’s important to add as little, or no, new debt as possible during the homebuying process.
Keeping your debt-to-income ratio low can help you qualify for a home loan and pave the way for other borrowing opportunities. It can also give you the peace of mind that comes from handling your finances responsibly.