Getting qualified for a mortgage actually pretty straightforward once you know what lenders are looking for. Several factors go into the mortgage approval process, including your credit history, credit score, job stability, down payment amount, and debt-to-income (DTI) ratio. Let’s take a closer look at DTI and see how it’s calculated.
How much debt do you have? Utilities, food and gas costs don't apply here.
How much money do you make before taxes or deductions?
Divide your total debt by your total income. The result is your debt-to-income ratio. Expressed as a percent.
Your mortgage probably won’t be the only loan or credit payment you have each month. When assessing your mortgage loan application, lenders want to know about these other debt obligations. Your mortgage offer is based on whether or not you’ll have enough monthly income to cover your mortgage payment and all of your other debts—and still be able to live comfortably and securely.
Mortgage companies don’t just look at your debt situation to make that assessment. They use a personal finance measure called DTI to compare your total level of debt to your overall income.
It’s a good idea to estimate your DTI before you apply for a mortgage or a refinance. This helps you avoid any unpleasant surprises that could keep you from securing a mortgage for your dream home, or lowering the interest rate on your current home loan.
You can calculate your DTI in three easy steps:
This should include your current rent or anticipated mortgage, all of your credit cards and retail charge cards, any student loans or car loans, as well as child support and alimony. Other living expenses like your utilities, food and gas, or public transportation costs are generally not included in the DTI calculation. (General idea is if you don’t have an account with a company, you probably don’t need to consider that expense as a debt.)
This is all of the income from your primary job and any side jobs before taxes or other deductions for your health insurance or retirement plan.
Then take the decimal that results from the above calculation and multiply it by 100 to put the DTI into percentage form.
Susie Q. Borrower is anticipating a $1,000 monthly mortgage payment. She also has two installment loans: one for her car that costs her $400 a month and another for her student loan that amounts to $200 a month. She pays $150 each on three credit card accounts every month. So, her total monthly debt load equals $2,050.
Susie brings home $6,250 in income before taxes each month from her full-time job. In addition, she works two Saturdays a month at a part-time job where she earns $400. That brings her total monthly gross income to $6,650.
When you divide her monthly debts of $2,050 by her $6,650 monthly gross income and multiply it by 100, Susie’s DTI amounts to 30.82%.
When it comes to DTI, the lower your ratio, the better your rate and loan terms. But there are also cutoffs for different programs. For example, at the time of this writing, for a Conventional loan, you must have a DTI lower than 50%, while FHA is 57%.
In the case of Susie Q. Borrower, she’s sitting pretty with a 30% DTI.
An optimal DTI—meaning your mortgage is likely to be approved and at a favorable interest rate—is 36% or less.
DTI might not be at the top of most people’s minds when they think of their personal finances, but it makes sense why lenders use it in their approval process.
After all, whether you’re dealing with an online lender or a traditional bank, loan underwriters want to gather a full picture of your financial situation before they’re willing to extend you a mortgage. Of course, they want to know your income level and job history, but they’re interested in how you spend your money and your other financial obligations as well.
Lenders review things like your credit score, credit utilization ratio and DTI because these factors provide them with a reliable indication of your willingness and ability to repay your debts.
According to the Consumer Financial Protection Bureau, the federal agency that protects consumers’ financial dealings, studies have shown that DTI is a particularly relevant piece of information for getting approved for a mortgage. Borrowers with higher DTI, especially those over 43%, tend to struggle more to repay their debts.
Lenders use your DTI to help determine whether or not you can pay your monthly mortgage payment along with all of your other debt payments.
If your DTI is on the higher end, it’s worth your while to try to lower it before you apply for a mortgage. You have two main options for achieving that goal—either lower your monthly debt payments or increase your monthly gross income.
With a little discipline and ingenuity, you can lower your monthly debt payments, which in turn lowers your DTI.
Whether you use the debt avalanche or the debt snowball method to pay them off, make a plan for reducing your credit card balances. While you’re at it, try not to put any more purchases on your accounts, especially for big ticket items that significantly increase your monthly payment.
Does your car loan or student loan have just a few more months of payments? Paying it off ahead of schedule reduces your DTI. If that isn’t an option, mention the impending payoff in your mortgage application. Most lenders are likely to leave it out of your DTI calculation.
If the interest rate on your student loan or car loan is higher than going rates, take a look at refinancing at a lower one and possibly changing your repayment terms. In addition to potentially paying less overall interest, this option may also result in a lower monthly payment, which helps reduce your DTI.
On the surface, bringing in more cash may seem like a challenge. But there are ways to accomplish this for a lower DTI.
If you have a performance review coming up—that's great. You can consider timing your mortgage application until after your performance review and the resulting raise. If that’s too far in the future or not something you can count on, consider proactively asking your boss for a pay increase—just be prepared to explain why you deserve the extra cash.
For non-salaried workers, ask about working more regular hours each week or ask about overtime opportunities.
Whichever you choose, be sure to chat through it with your loan advisor—they’ll help you ensure you’re making the most effective use of your work to increase your DTI. If you have any questions about DTI, we’re here to help.
You can use an online DTI calculator to figure out how much debt you need to pay off or extra income you need to earn to get a more favorable DTI.
Once you understand what mortgage terms like DTI mean, you’ll be better prepared to take on the homebuying process with confidence.