Your debt-to-income ratio (DTI) is one of the key elements lenders consider when assessing your mortgage loan application. It helps determine if you have enough financial resources to repay a new loan and also serves as an indicator for how well you manage debt.
Debt-to-income ratio for mortgage approval is a measure of how much your current monthly debt payments (including any mortgage payments you have) compare to your total pre-tax income. It’s calculated by dividing any minimum monthly obligations such as credit card minimum balances, car loans, student loans or other recurring financial obligations by gross monthly income before tax.
The higher your debt-to-income ratio (DTI), the more likely lenders will decline your mortgage application. However, it is possible to reduce this number and still receive approval for a home loan.
How to Lower Your DTI for Mortgage Approval
The initial step is creating a budget and adhering to it. This will help reduce monthly spending, increase debt payments each month, help pay off existing debt faster, and lower your overall DTI.
Another essential step to reduce your debt-to-income ratio (DTI) is paying off non-mortgage debt quickly. Doing this will lower monthly payments and give you a better chance at qualifying for mortgage financing in the future.
Calculating Your DTI for Mortgage Approval
Lenders calculate debt-to-income ratio (DTI) using two different methods. Front-end DTI and back-end DTI both take into account gross monthly income when calculating the DTI.
Front-end DTI: This type of debt repayment ratio takes into account all housing expenses, such as your monthly mortgage payment, property taxes and homeowner’s insurance. It’s usually considered more significant than the back-end DTI since it provides lenders with a comprehensive view of your finances and how they affect total monthly income.
For instance, if your mortgage is $1,700 and you owe $250 in escrowed property taxes and homeowner’s insurance, then your front-end debt-to-income ratio (DTI) is 34%.
If your debt-to-income ratio (DTI) is high, the most effective way to lower it is by paying off credit card and car loans as quickly as possible. Doing this will reduce monthly payments and boost income, ultimately leading to a decrease in DTI.
You could also strive to earn more, as this will raise your overall income and reduce your debt-to-income ratio (DTI). Doing so may make it simpler to qualify for a mortgage loan or purchase a new home.
Your debt-to-income ratio (DTI) is calculated by dividing the sum of all monthly debt payments – such as mortgage payments, credit card minimum balances and other recurring financial obligations – by your pre-tax income. This percentage may differ from lender to lender.
Lenders prefer a Debt-To-Income ratio (DTI) below 36 percent, with no more than 28 percent used to service mortgage or rent payments. A DTI higher than this can cause greater difficulty getting approved for loans or credit cards and may even mean you pay an increased interest rate.