Your debt-to-income ratio (DTI) plays a big role in whether you are ready and able to qualify for a mortgage. It is the percentage of your income that goes towards paying off your monthly debt and will help lenders make a decision how much can you borrow. DTI is just as important as, if not more, your creditworthiness and job stability.
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Calculate your DTI
Calculation of the debt-income ratio
Lenders calculate your debt-to-income ratio by dividing your monthly debt obligations by your pre-tax or gross income. Most lenders look for a rate of 36% or less, although there are exceptions that we will discuss below.
“The debt-to-income ratio is calculated by dividing your monthly debt by your pre-tax income.”
DTI sometimes omits monthly expenses such as groceries, utilities, transportation, and health insurance among others; Lenders may not take these costs into account and may allow you to borrow more than you want to pay. So keep these additional obligations in mind when considering how much you are willing to pay each month.
You want the lowest possible DTI, not just to qualify the best mortgage lenders and buy the home you want, but also to pay off your debts and live comfortably at the same time.
Types of Debt-Income Ratios
DTI is not a complete measure of affordability
Although DTIs are important when you take out a mortgage, they are not enough to find out what you can afford, says Ira Rheingold, executive director of the Federal Association of Consumer Guards.
“You can have these general guidelines on debt-to-income ratios,” he says, “but the bigger question is, once you have the mortgage payment, will you have enough money to make ends meet?”
Since DTIs don’t account for expenses such as groceries, health insurance, utilities, gas, and entertainment, you should budget beyond what your DTI describes as “affordable.” The goal below the backend goal of 36% is ideal.
This is especially important as DTIs count your pre-tax income, not what you actually take home with you each month.
How to lower your DTI
The higher your DTI, the more likely it is that you will have difficulty qualifying for a mortgage and making your monthly mortgage payments.
There are several ways to lower your debt-to-income ratio:
Don’t make large purchases on credit before buying a home.
Try to pay off as much of your current debt as possible before applying for a mortgage.
While getting a job raise is another way to lower your DTI, getting one quickly may not be possible. So it is better not to take on any more debt and work to reduce the debt that you have.
In most cases, lenders will not include installment debt such as car or student loans as part of your DTI if you only have a few months to pay them off.
If your DTI is high, don’t apply just yet
If your debt-to-income ratio is exceptionally high – say 50% or more – you should probably wait before buying a home.
“The best way to get your DTI down is to reduce the debt you have and avoid taking on more.”
“There is nothing wrong with saying, ‘I have to wait another year before I buy a house,’” says Rheingold. He suggests getting your finances in order so that you present yourself as someone with good credit and little debt.
Before you sit down with a lender, use a Mortgage calculator is one way of determining an adequate mortgage payment for you.
The lower your debt-to-income ratio, the safer you are with lenders – and the better your finances will be.