How debt-to-income ratio can affect your mortgage application
If you're a first time homebuyer, then the process can seem overwhelming. This video series, presented by Chase Home Lending, translates relatable experiences into tips and tools that equip you for every step of your homebuying journey.
You earn a steady income and pay your bills on time. Yet it's your debt-to-income ratio that could make or break your chances of getting a mortgage. Here's why it matters for loan approval:
Calculating debt-to-income ratio
Debt-to-income ratio is the percentage of your gross monthly income that goes toward paying debts. It is calculated by adding all of your monthly debt payments and dividing them by your gross monthly income, which is the amount of money you have earned before taxes and other deductions are taken out.
A good rule of thumb is to keep the debt-to-income ratio below 36 percent. This will increase your chances of getting a loan.
For example, if you pay $1,500 a month for your mortgage, another $200 a month for an auto loan and $300 a month for remaining debts, your monthly debt payments add up to $2,000. If your gross monthly income is $6,000, then your debt-to-income ratio is 33 percent ($2,000 is 33 percent of $6,000).
On the other hand, if your gross monthly income is $6,000, and you are paying $3,000 in monthly debt, your debt-to-income ratio is 50 percent. In this case, you would be considered "house poor", a term used to describe homeowners who are living beyond their means by spending a majority of income on housing costs (including mortgage, taxes and insurance).
Lenders also review related housing expenses such as condominium dues and homeowner association assessments, insurance premiums, mortgage insurance and other recurring obligations.
While a high credit score is considered good, a low debt-to-income ratio is a more important factor. Lenders look at the big picture to determine whether you can comfortably manage monthly bills.
Pay down debt
You can reduce your debt-to-income ratio by increasing your income or paying off loans and credit card accounts. If your lender will not calculate earnings from side jobs as income, you can use the extra money to pay down debt. You can also allocate funds from bonus pay or a cash windfall to reduce debt.
Lenders also look at student loan debt when calculating debt-to-income ratio. Whether it will count against you depends on the type of loan and whether the payments are current or have been deferred.
Reimagine your dream home
A debt-to-income evaluation could serve as a heads-up to consider a home that better fits your budget. After all, the adventure of making one of your largest financial purchases should have a happy ending.