Home Buyer's Guide to Debt-to-Income Ratio

There are many things that a home buyer must take into consideration when they're trying to decide whether they're ready to buy a home, especially if it's a first home. Debt-to-income ratio (DTI) is one of those factors.

If you're thinking about buying a home sometime in the next several months, now is the time to find out what your debt-to-income ratio is, how it will impact your ability to buy a home, and what you can do to change your debt-to-income ratio (if it's too high). Understanding these matters can help you plan for the future, so you can position yourself to borrow money if you're planning to borrow a mortgage.

For informational purposes only. Always consult with a licensed mortgage professional before proceeding with any real estate transaction.

What Is Debt-to-Income Ratio?

Debt-to-income ratio is the amount you pay in debt every month divided by your monthly gross income. DTI is usually expressed as a percentage. For example, if you make $6,000 per month and pay $1,200 in debt every month, your debt-to-income ratio is 20%.

How Does Debt-to-Income Ratio Affect Your Ability to Buy a Home?

Most lenders use debt-to-income ratio as a way to gauge how likely it is that a home buyer will be able to pay back a mortgage. The more money a home buyer pays in monthly debts, the more difficult it may be for that home buyer to pay their monthly mortgage. People who have a high DTI may be considered high-risk borrowers. High-risk borrowers typically have a higher mortgage default rate.

Because of this correlation, many lenders will not loan money to people who have a high debt-to-income ratio. Lenders who will approve a mortgage often charge high interest rates, and may also severely limit the amount of money they'll lend.

How Can You Calculate Your Debt-to-Income Ratio?

There are a variety of debt-to-income ratio calculators online. Before using an online calculator, the buyer must know their normal monthly income, including any money from their second job or their spouse's job, and how much they pay to debtors every month. Debt is considered any kind of loan or repayment, including student loans and auto loans.

Buyers who want to ensure their DTI is accurate can contact a lender. A good lender will be able to calculate DTI just by asking a few simple questions and plugging the information into a formula. Many lenders will not allow buyers to take on a debt-to-income ratio higher than about 43%. This means that even if a buyer has a relatively low DTI before buying a home, the lender will not allow the buyer to qualify for a mortgage that would push their total DTI above 43%. A borrower who has a DTI of 38% without a mortgage may not be able to borrow enough money to buy a home.

How Can You Lower Your Debt-to-Income Ratio?

For many buyers, the only way to lower debt-to-income ratio is to pay off debts. This often involves careful budgeting and planning. Some buyers are tempted to pay off their debts using their savings, but this is not advisable.

A healthy savings is critical during the home buying process. In addition to the down payment, buyers must pay closing costs, moving expenses, and other associated costs. After moving in, many buyers need money to make changes to their new home, to buy new furniture and to make repairs if they're needed.

Sometimes Canyon Meadows home buyers are able to reduce their debt-to-income ratio by increasing their income. This may be a realistic option for couples who have a high DTI because one spouse works and the other spouse doesn't. Buyers who are thinking about getting a new job to lower their DTI should talk to a lender. The lender can tell them how much more money they need to make per month in order to achieve their optimal DTI.

Talk to a Lender and a Real Estate Professional

If you're thinking about buying a home sometime in the next several months, have a conversation with a capable lender and real estate professional. Your lender can assess your financial situation, make recommendations to help you improve your finances, and can tell you how much money you'll be eligible to borrow when you're ready to buy a home.

Talking to a good real estate professional can help you find out which homes will fall in your budget, given how much money you're able to borrow. This can help you plan for the day when it's time to find a home.

For informational purposes only. Always consult with a licensed mortgage professional before proceeding with any real estate transaction.