Debt to Income Ratio
The debt-to-income ratio is one of the most important factors mortgage lenders use to evaluate the creditworthiness of borrowers.
Calculating the Debt-to-Income Ratio
Expenses include things like car payments, credit card payments, student loan payments, child support payments etc. It’s important to note that it does not consider the amount of money you spend for living expenses. In other words, things like car insurance, groceries, phone bills, entertainment expenses, utilities etc. are not included.
DTI = Monthly Expenses + Proposed Mortgage Payment
GROSS Monthly Income
The Ideal DTI Ratio for Mortgage
Even though your DTI ratio is a major factor for loan approval, it’s not the only factor.Mortgage companies want to lend money to homebuyers with low DTI Ratios. The higher your ratio, the more “risky” you become.
Depending on the type of loan you select, the maximum DTI Ratio changes. However, below is a good rule to follow:
1. DTI Ratio less than 43% is considered “great”. This shows your debt is at a manageable level and you have money left over once your bills are paid. If you can lower this, even better but most loan programs view this as an acceptable level of risk.
2. DTI Ratio in the 43 – 49% range is considered “good”. It’s not optimal and ideally should be lowered so that you’re better able to handle any unexpected expenses. If you are in this range, the mortgage company may ask you to meet additional eligibility requirements.
3. DTI Ratio is 50% or higher, your borrowing options may be limited. Many are able to get approved in this range, but look for ways to lower your DTI.
How to lower your DTI Ratio
There are two ways to lower your DTI: reducing your expenses or increasing your income. Below are a few tips for decreasing your DTI Ratio.
- Make extra payments to your credit cards to lower the balance
- Reduce your day to day expenses to put more money towards other debts
- Avoid making large purchases on credit that aren’t absolutely necessary
- Avoid opening new lines of credit
- Ask for a raise
- Take on a part-time job (this is a longer term fix since there are guidelines on when you can count the part-time income for qualification purposes).
- Don’t spend as much on your home – lower the mortgage payment.
- Increase your credit score, which could lower your interest rates for the purchase –meaning less mortgage payment
Bottom line: Try and keep your DTI Ratio as low as possible. Speak to your Advisor as soon as possible as they can help create a plan to get your ratio at an acceptable range.