It’s no secret that your income and credit score are two of the most significant factors that determine whether you’re able to buy a house. But these aren’t the only factors that mortgage lenders consider. We also calculate your debt-to-income ratio (DTI), which provides a pretty accurate estimation of how much you can borrow. What exactly is DTI? And most importantly, how does DTI affect buying a house?
WHAT IS DTI?
In the lending world, especially the mortgage industry, DTI refers to the percentage of your monthly gross income that goes toward paying your debt. It compares your debt to your overall income. The less obligation you have, the lower your debt-to-income ratio, and the easier it may be to get a mortgage.
Affordability is critical when buying a house and calculating your debt-to-income ratio is one way to assess how much you can realistically spend on a property. Typically, your mortgage payment should not exceed about a third of your gross monthly income. But just because a payment is 28% to 30% of your gross income doesn’t mean that you can afford it.
Depending on the amount of income going toward other monthly debts, a mortgage payment within these percentages might be too expensive for you. That is a reason that lenders calculate DTI — to get a better picture of affordability.
As a general rule of thumb, your overall debt-to-income ratio, including your future mortgage payment, shouldn’t exceed 36% to 43% of your gross monthly income.
To calculate your DTI, simply add up all your minimum monthly debt payments and then divide this number by your monthly gross income. If you have a monthly gross income of $6,000 and monthly debt payments of $1,500, your debt-to-income ratio is 25%.
On the other hand, if a mortgage increases your monthly debt payments to $3,000, your DTI jumps to 50%. You might not qualify for some homes until you’ve paid down or eliminated some of your other debts. This can include paying off car loans, student loans, credit cards, and other loans.
HOW TO IMPROVE YOUR DEBT-TO-INCOME RATIO?
Improving your DTI can increase your purchasing power, allowing you to get more house for your money. A lower DTI also helps you get a lower mortgage interest rate. The best way to improve DTI is to pay off as much of your consumer debt as possible before applying for a mortgage.
Another option is to get a mortgage with a co-borrower, maybe adding your spouse to the mortgage loan (if he/she has good credit). Lenders will use your combined income for qualifying purposes. But keep in mind that underwriters will examine both credit reports. So ideally, the less debt you both have, the better.
Ready to buy a house? Please contact the loan experts at FirstBank Mortgage to discuss your loan options.