Homebuyers

Keeping an Eye on Your DTI: Why Debt-to-Income Ratios Matter for Homebuyers

If you’re hoping to purchase a home with a mortgage, you may want to consider paying down your credit cards and student loan debt. That’s because how much debt you have can make or break your ability to qualify for a home loan.

Lenders will typically look at your debt-to-income (DTI) ratio when deciding whether to approve your mortgage application.  Your DTI is the amount of money you owe versus how much money you bring in.

If someone has a lot of debt relative to their income, they may not be able to qualify for a mortgage—or they may be offered a smaller loan than they would have liked. In some cases, borrowers may be charged higher mortgage rates because lenders may see them as riskier clients.

Lenders evaluate your DTI along with your income, credit score, and assets when measuring your financial ability to buy a home. They also consider your cash reserves and estimated insurance costs and local property taxes.

If any of these things change, your DTI may as well. 

“You can attack your income. You can attack your debt. You can attack your purchase price. You can attack homeowners insurance or taxes,” said Chris Thomson, a loan officer with NAF who is based in Tustin, Calif. “Your DTI is a byproduct of all of these other factors.”

What is DTI?

The simplest way for you to calculate your basic DTI is to take your total monthly debt payments, which includes student loan debt, car, and credit card payments, and add it all up. Then you divide that number by your monthly income before taxes. This will give you your current DTI.

Lenders factor in the mortgage payment including the estimated property taxes, homeowners insurance, homeowners association fees, and things like flood insurance if that is required. This helps them figure out if someone can afford the home.

Ideally, lenders want to see a DTI of less than 36% or less, the lower the better. However, many lenders may accept a DTI up to 43%. Some homebuyers may be able to qualify for a loan with a higher DTI, depending on the size of the loan, their credit, income, and assets.

Your credit score also affects the debt ratios your lender will accept.

“It’s really this puzzle to put together,” said Thomson. “If your credit score is higher, then your debt ratios can be higher. Typically, if your credit score is low, then your debt ratios are going to have to be lower.”

How to change your DTI

The simplest way to change your DTI is to either pay off your debt or increase your income.

You can start by looking at debt consolidation programs, talking to a financial advisor (they sometimes do consultations for free), and applying for higher-paying jobs or taking on a side gig.  

“It is always better, if you are looking at one or the other, to reduce expense versus increase income,” said Thomson.

There are other potential solutions as well.

For example, a lower mortgage interest rate may lower your DTI as well.  

“The interest rate plus the loan amount determines what your monthly payment is going to be,” said Thomson. “The less expensive the loan is, the lower the DTI is going to be assuming that all other factors stay static.”

Location can also impact your DTI. Property taxes and home insurance requirements and premiums change based on where your home is based.  

For instance, an area more at risk for hurricane damage may have higher wind insurance premiums than an area further from the coast.

Property taxes also vary by location. If you find a home with lower insurance costs and taxes, that could lower your DTI compared to if you were hoping to purchase a home in a higher-cost area.

Talking to your lender about DTI

Homebuyers may think it’s always better to put their savings toward paying off debt. However, it’s good to have a bit of a financial cushion when you go into your new home.

You’ll probably want to purchase new furniture or make changes to the home—and you never know when an emergency could crop up.

That’s why it may be a good idea to talk to a mortgage professional who can help you to look at different scenarios and options.

“If we're making a decision between more or less in your pocket and a marginal difference in monthly payment, I'd rather you go into a new home with a little bit more in the bank account,” said Thomson.  

Chris Thomson NMLS # 186656