If you’re planning to buy a house, one of the things you must be thinking about is whether you can get a mortgage. Do you qualify for a home loan? What are some of the things that can increase your chances of getting a good mortgage with low-interest rates?

When you make your mortgage application, your lender will first check whether you qualify or not. One of the things they look at is your debt-to-income ratio. Many lenders consider an excellent debt-to-income ratio to be 36% and lower. Anything above that is considered risky, and many lenders might not want to do business with you.

But what’s the debt-to-income ratio, and how does it affect your borrowing life and financial health in general? How do you calculate your debt to income ratio? If you don’t know how DTI works, this article is for you.

What Is Debt-to-Income Ratio?

The debt-to-income ratio is simple as it sounds. It’s the total amount of your monthly debts versus your income. It calculates the percentage of your monthly income that goes to various debts like a student loan, income taxes, car insurance, and mortgage, divided by your gross income. The DTI helps lenders determine whether they’ll make a good decision lending you money or not. It’s simply a measure of your creditworthiness.

Many lenders look at a DTI of 36% or lower as good enough. While many people are usually scared of the 43% rule, you can still qualify for a mortgage with a DTI of 43% or higher. This will depend on the lender qualification standards and whether you meet them. To understand how everything works, you must dig deeper into what lenders consider when calculation DTI.

Calculating Debt-to-Income Ratio

To calculate your debt-to-income ratio, you need to add up all your recurring debt and divide the number by your monthly income. The debts include student loans, car payments, child support, housing payment, alimony, and personal loans.

Lenders calculate your DTI by adding your current debt and any potential future debt. They then divide the figure they get with your pre-tax or gross income. That means they also add your new mortgage application to your monthly debt. With this number, they get an idea of your debt management and predict your ability to service your mortgage loan.

According to most lenders, a good DTI should be 36% or below. However, many lenders still have exceptions to this figure.

The calculations of DTI do not factor in your living expenses. You’ll not need to worry about your grocery expenses, entertainment cost, transportation fees, utilities, or insurance payments when doing your debt-to-income ratio calculations. But when considering the amount you’re going to take home after paying your debts plus the new mortgage, you should worry about these expenses. Your loans plus all your expenses should not exceed your income.

You need a low DTI, not only to qualify for a good mortgage but also to live a comfortable life. You don’t want to use up all the money you have and end up with nothing to take home. If that’s the case, you’ll be in a situation known as a debt trap.

What Do the Numbers Mean?

So you’ve calculated your DTI and gotten your numbers, but what does it mean? If you’re a financially responsible person, you should calculate the debt-to-income ratio not only because you’re applying for a mortgage but also to know where your financial health stands.

A lower number, usually anything below 36%, is considered a good number. This means you have fewer debts to service, and your income is pretty good. You have good chances of qualifying for a loan, such as a mortgage if you need one.

However, a higher number, usually 37% to 43%, means you have very little to spare. Many lenders will not be willing to give you their money with this number. Well, other lenders will still give you a mortgage with this number. But you shouldn’t be in a hurry to take it because it comes with its share of drawbacks.

Instead of taking a loan with a high DTI and putting yourself in deeper financial struggles, you should consider reviewing your financial health. Experts agree that if you happen to reach a 50% DTI, you’re risking your financial health. Any lender willing to give you a mortgage with this ratio is pushing you further into economic decline. You should strive to push your debt-to-income ratio towards 0% as much as possible. Everyone should strive to get to a debt-free life to consider themselves financially healthy.

Debt to Income Ratio and Mortgage

Mortgage lenders are very strict when it comes to DTI. They look at your finances, credit history, your gross income, and your down payment amount. They’ll also calculate your debt-to-income ratio to determine how much you can afford. While many mortgage lenders consider 36% DTI as a good number, not more than 28% of that should go towards servicing your mortgage.

If you get a lender with better standards, you’ll still qualify for a mortgage with 43% DTI. But this is the highest number you can go towards qualifying for a mortgage. Anything above that means you’re not a responsible borrower.  You’ll typically show your lender that your expenses on other loans are too high, and adding you a loan will be a considerable risk.

With a low debt-to-income ratio, you will increase your chances of qualifying for a mortgage with the lowest interest rates. Remember, lenders that usually agree to give you a mortgage loan with a high DTI charge more when it comes to high-interest rates. So, if you want to get your mortgage from a reputable lender with favorable interest rates, check your DTI and keep it low.

How to Lower Your Debt-to-Income Ratio

A high DTI doesn’t only mean you’ll struggle to get a mortgage, but it’s a good indication that you’re struggling financially. This also means your credit score is at risk of getting lower, putting you in even more difficult borrowing capabilities. Therefore, you should do all it takes to lower your DTI. Here’s how to do that.

  • Don’t apply for more debt with a high DTI.
  • Pay much of your current debts to lower your DTI.
  • Avoid big credit card purchases until you’re able to qualify for a mortgage.
  • Increase the amount that goes towards your debt payment.
  • Don’t take more debt if your target is to qualify for a mortgage with a lower DTI.
  • Calculate your monthly debt-to-income ratio to see if you’re making any progress.
  • Include someone else, like a spouse, on the mortgage application. This way, your mortgage lender will consider the DTI from the two of you, and it might be lower.
  • Consider taking a side hustle to raise your income so you can afford your loan payments and have a lower DTI.

Bottom Line

Keeping your debt-to-income ratio low is not all about qualifying for a mortgage. It has more to do with your financial health. You should make it a routine always to calculate your DTI ratio and ensure everything is within control. With this kind of discipline, you’ll be in a better position to apply for a mortgage and qualify when you are ready to buy a home.

Understanding your debt-to-income ratio (DTI) is a crucial aspect of securing a mortgage for your dream home. Your total monthly debt payments, including credit utilization like personal loans, car loans, and monthly mortgage payments, should not exceed a certain percentage of your gross monthly income. This percentage varies by lender and loan type but maintaining a low ratio will ensure that your monthly debt obligations are manageable and demonstrate to lenders that you're a responsible borrower.

FHA loans, in particular, allow higher debt-to-income ratios, potentially enabling home buyers with substantial debt to still qualify. However, taking on too much debt may make monthly payments on your new home more challenging and could affect your ability to cover other monthly expenses. Therefore, always consider the balance between your total monthly income and your debt obligations.

Lastly, it's important to remember that your monthly mortgage payment includes more than just the principal and interest; it also includes components like property taxes and insurance. Your DTI calculation should take all these factors into account to ensure you're not taking on more house than you can afford. By keeping track of these numbers and maintaining a reasonable balance between your monthly gross income and your monthly mortgage payments, you can successfully navigate the path towards homeownership.