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I’ve talked about pre-approval vs pre-underwriting. I also explained loan-to-value. But another term any home buyer who finances their mortgage needs to understand is debt-to-income. Why? Because it may mean the difference between loan approval and heartbreak.
Debt-to-Income Ratio
What is It?
In a nutshell, the debt-to-income ratio (DTI) is how much of your income is used to pay your debts. These debts include credit card payments, car loan/lease payments. student loan payments, child support, and mortgage or rent payments among other things. To determine your DTI, take the total of all of these payments and divide it by your monthly income before taxes. For example, let’s say that your payments total $2500. Your annual household income is $84,000. That works out to $7000 a month before taxes. A lower debt load looks much more attractive to lenders than a higher debt load. And if your DTI ratio goes above a certain percentage, lenders may decide that you are not a good credit risk.
What is a Good DTI?
The number varies from lender to lender. However, typically, lenders like to see a DTI of around 36%. However, some lenders go as high as 43%. Of that debt, no more than 28% should go toward your mortgage. In the example I gave above, $2500 falls just under 36% of your income. If your DTI gets too high, you run the risk of not being able to meet all of your financial obligations. Therefore, you run a higher possibility of defaulting on your loan.
What to Do Before You Apply for a Mortgage
Tackle your debt load. Pay down balances on all of your revolving credit accounts. Get your credit card balances under 30% of their limits. Why? Lenders also look at credit utilization. Maxed out on your credit cards? Lenders see this as fiscal irresponsibility or that your finances are stretched as far as they can possibly go. Neither one of these looks great to banks. Start lowering your debt-to-income ratio as soon as possible to present yourself in the best possible light when it comes time to apply for a mortgage loan.
Muna Dionne, your Inland Empire specialist with Coldwell Banker Realty
