If you apply for a mortgage to buy a house, a lender will look at your overall financial picture to figure out if you can afford to repay a loan and to decide how much money to give you. One factor a lender will consider is your debt-to-income ratio.
What Is a Debt-to-Income Ratio?
Your DTI ratio is the percentage of your monthly income that you spend on your debts. A customer’s debt-to-income ratio is one way that lenders assess risk.
If your DTI ratio is at or below a specific percentage, a lender will be confident that you’ll be able to make mortgage payments on time. A lender will therefore be likely to offer you a loan with an attractive interest rate. If your DTI ratio is too high, it might be difficult to get approved for a mortgage, or you might only qualify for a loan with a high interest rate.
How Is Debt-to-Income Ratio Calculated?
There are two types of debt-to-income ratios. A lender might consider one or both of them when evaluating your mortgage application.
A lender will calculate your front-end DTI ratio by adding up the total you spend on housing-related expenses, such as mortgage principal, interest, taxes and insurance. That figure will then be divided by your gross monthly income (i.e., your earnings before taxes are deducted) and converted to a percentage.
A back-end ratio will include your other debts, such as monthly payments on auto, student and personal loans. If you carry credit card balances, a lender will use your minimum monthly payments when calculating your DTI ratio. If you make alimony or child support payments, or if you have any other debts, those will also be factored into your debt-to-income ratio.
Your total debts will be divided by your gross monthly income and converted to a percentage. Other common expenses, such as groceries, transportation and utilities, are generally not included when calculating a DTI ratio.
How Can You Lower Your Debt-to-Income Ratio?
Each lender has its own requirements. If your debt-to-income ratio is too high for you to get a loan from one company, you might be able to qualify for a mortgage through a different financial institution, but the loan might have a high interest rate.
Lowering your debt-to-income ratio can improve your chances of getting a mortgage with favorable terms. You can do that by reducing your debt load and/or increasing your income.
Work on paying off any outstanding loans or credit card balances that you have. Look for ways to reduce your other expenses so you can put more money toward debt each month. Consider consolidating debts to lower your interest rates and monthly payments. Think about taking on a part-time job or side gig to increase your income.
