What Is a Good Debt to Income Ratio When Applying for a Mortgage?
Your debt-to-income (DTI) ratio is a crucial factor lenders consider when evaluating your mortgage application . This number compares your monthly debt payments to your gross monthly income, providing insight into your financial health and ability to manage your mortgage payments. Simply put: Lenders use your DTI ratio to determine your credit risk. Here’s what you need to know about how the DTI ratio is calculated and what you can do to put yourself in the best credit position.
How to Calculate DTI Ratio (And Why You Should Do It)
Your debt-to-income ratio is calculated by dividing your total monthly debt payments by your gross monthly income (that is, before taxes). For example, if your monthly debt is $2,000 and your gross monthly income is $6,000, your DTI ratio would be 33% ($2,000 / $6,000 = 0.33).
The main purpose of calculating the DTI ratio is to assess risk. While your credit score tells lenders how you’ve managed your loan payments in the past, your DTI tells lenders whether you currently have enough money to pay off your loan in the future. A lower DTI suggests you are more likely to successfully manage your mortgage payments. A lower DTI ratio can not only improve your chances of getting approved for a mortgage, but can even help you qualify for better interest rates and loan terms.
Ideal DTI Ratios for Mortgages
According to the Consumer Financial Protection Bureau , 43% is generally the highest DTI ratio a borrower can have and still qualify for a mortgage. However, lenders generally prefer a DTI ratio below 36%. Ideally, no more than 28-35% of your total income should go towards servicing your mortgage.
Tips for Improving DTI Ratio
If your DTI is higher than you want, it may not be the best time to apply for a mortgage. There is no easy solution here: your best bet is to pay off your existing debts . Consider asking lenders to lower your interest rate , which will build up funds that you can use to pay off your debt. Likewise, increasing your income will also improve your DTI ratio. If you are focused on improving your score, refrain from applying for a new loan or loan as it will negatively impact your DTI ratio.
Remember that while DTI is important, it is not a deciding factor until you are around 43%. This is just one factor that lenders consider, while elements like your credit score, employment history and down payment play a larger role in the mortgage approval process.
For more information on the home buying process, check out my How We Bought Our First Home series here . And if you’d like to share your experience of buying your first home, leave a comment below. Perhaps you can help paint a bigger picture of what navigating the housing market looks like these days, especially without generational wealth.