When applying for a home mortgage, how do you know how much loan amount you can afford? The key is your debt-to-income ratio. The debt-to-income ratio is a critical measurement that underwriters use to determine your ability to repay the loan. Given its importance to the lending decision, it is critical to understand the debt-to-income ratio and what you can do to improve it.
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What is your debt-to-income ratio?
You actually have two debt-to-income ratios that lenders use to determine if you can afford a new mortgage. The first is what’s known as the front-end ratio or housing ratio. The housing ratio is your proposed total monthly housing payment (new mortgage payment, property taxes and insurance combined) divided by your gross monthly income. The other important ratio is known as the total debt ratio. In addition to your housing payment, the total debt ratio factors in other monthly credit obligations such as car loans, credit cards and student loans.
What is an acceptable debt-to-income ratio?
Most lenders do not have maximum debt-to-income ratios per se, but rather guidelines that offer some flexibility. In general, lenders want to see monthly housing debt of no more than 28% to 33% of your income and total debt of no more than 38% of your income. Lenders will exceed these guidelines when sufficient offsetting factors exist, such as excellent credit, larger than required equity or down payment, or demonstrated ability to maintain a similar payment. Keep in mind, however, that the farther you exceed the guidelines, the stronger your offsetting factors will need to be.
How can I improve my debt-to-income ratio?
The nice thing about the debt-to-income ratio is that, unlike some other aspects of your financial life, it can be improved. You may be able to, for example, improve your debt-to-income ratio by paying off some of that excess debt. But be sure to check with your lender before you start paying that debt down, because lender requirements do vary.
Find out how much you could save with your debt-to-income ratio
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