What Debt To Income Ratio I Need To Buy a Home

Homebuyers often ask: “What debt to income ratio do I need to buy a home?”. We’ll show you the ratio that most mortgage lenders seek when qualifying you to buy a home.

 

KEY TAKEAWAYS

• Mortgage lenders use your debt-to-income ratio to measure your ability to repay money borrowed on a monthly basis.
• Learn what is a Debt-to-Income (DTI) ratio and how to calculate it.
• Learn how using credit impacts your credit score, but not the debt-to-credit ratio.
• Discover what is a good Debt-to-Income (DTI) ratio for a mortgage.
• Learn two ways to lower your debt-to-income (DTI) ratio.
• Making smart savings plan to pay off debts on a budget contributes to fixing poor debt-to-credit ratios over time.
• Access a free online mortgage calculator to help decide what you can afford to buy.

 

What is a Debt-to-Income (DTI) Ratio?

 

According to Investopedia, a debt-to-income ratio (DTI) compares your amount of debt to your total income. Mortgage lenders use this as a personal finance measure to know your ability to make monthly payments to repay money you borrowed. Thus, your DTI helps lenders decide “how much you can borrow”.

A low debt-to-income ratio shows a healthy balance between income and debt. Receiving a line of credit you seek depends on a low DTI percentage.

In contrast, high debt-to-income ratios show too much debt for your income to pay off. Lenders reject loan applications based on a high DTI.

 

How to Calculate Debt-to-Income Ratio

 

Calculating your debt-to-income ratio involves adding your total recurring monthly debts (like auto and student loans, a mortgage, credit card payments, and child support). Then, divide by your gross monthly income (before deductions and taxes).

Note: DTI leaves out many monthly expenses like utilities, food, health insurance, and transportation, amongst others.

For example, if you pay $1,000 for your mortgage, $500 for your car, and $400 for the rest of your debts every month. Your monthly debt payments add up to:

$1,000 + $500 + $400 = $1,900

If your monthly gross income is $5,700 your debt-to-income ratio is 33% ($1,900 ÷ $5,700 = 0.33). Yet, if your monthly gross income is lower like $5,000 your debt-to-income ratio is 38% ($1,900 ÷ $5,000 = 0.38). This creates a higher DTI.

 

What is a Good Debt-to-Income (DTI) Ratio for a Mortgage?

 

Applying for a mortgage requires your lender to consider your finances. This includes your monthly gross income, your credit history, and the money you have for your down payment. Your lender then figures out how much you can afford for a home by calculating your debt-to-income ratio.

Your DTI is always expressed as a percentage after dividing your total recurring monthly debt by your monthly gross income.

Strive for the lowest DTI to qualify for your mortgage ensuring you can pay your debts while living comfortably.

A good DTI ratio for a mortgage according to Investopedia is lower than 36%. According to NerdWallet, a higher than 36% DTI ratio means “you’ll pay more interest or be denied a loan”.

Also, only 28% or less must service your mortgage. That means if your gross monthly income is $5,000, then the maximum amount of your monthly mortgage payments is 28% at $1,400 ($5,000 x 0.28 = $1,400).

Of course, your total debts count too. Your lender will only want a maximum of 36% debt. In this case, $1,800 ($5,000 x 0.36 = $1,800).

 

Your DTI and Credit Score

 

Your DTI will not affect your credit score. That’s because credit agencies don’t know your income. So, they can’t calculate your debt-to-income ratio.

Yet, credit agencies look at your credit usage ratio (debt-to-credit ratio). This means they compare all your credit card accounts balances with the total amount of credit limits. Yes, they don’t consider how much credit you use, but rather the credit limits available.

For example, if your credit card balances total $5,000 with a credit limit of $10,000, your debt-to-credit ratio is 50% ($5,000 ÷ $10,000 = 0.50).

Thus, what you owe relative to your credit limit. Or, how close to maxing out the cards.

 

How to Lower Your Debt-to-Income (DTI) Ratio

 

Two ways to lower your debt-to-income (DTI) ratio:

1. Reducing your monthly recurrent debt; or
2. Increase your gross monthly income.

Also, you can combine the two. Let’s explore how you can accomplish these.

Reducing your monthly debt is tricky. You might want to prioritize your monthly expenses. For instance, consider your needs versus your wants. To survive, you need to pay for your shelter, food, healthcare, clothing, and transportation. Wants may include your favorite liquors, going out for meals, entertainment ventures, club memberships, and sports activities.

Increasing your income can occur with the following options:

• Add extra hours or overtime at your primary job;
• Get a second job or as a freelance remote worker;
• Ask your employer for a pay increase; or
• Increase your skills by completing classes or training to get a certification or licensing for a new job with a greater salary.

 

Have questions?

 

Free Online Mortgage Calculator

 

Bankrate provides a free online mortgage calculator where you can:

• Set the home price;
• Down payment;
• Length of Loan (years);
• Interest rate; and
• Advanced options.
• They provide detailed instructions and explanations for each category. Also, how their mortgage payment formula works.

It will show your estimated monthly payment broken down into the typical costs included with a mortgage payment like:

• Principal & interest;
• Homeowner’s insurance;
• Property tax; and
• HOA fees (if relevant).

Also, you can set different Amortization schedules.

This calculator lets you change the loan length and down payment to see what works better within your budget. It also lets you consider an adjustable-rate mortgage (ARM) as an alternative. It even lets you decide on “how much house can you afford”?

Plus, it gives you tips on “how to lower your monthly mortgage payment”.

 

Big Block Realty Blog Helps You Understand the Mortgage Process

 

We publish blog posts helping home buyers with understanding the complex mortgage process like:

• What To Expect During The California Mortgage Process;
• How To Successfully Buy a Home;
• Improve Your Chances for Home Loan Approval; and
• Financing Tips for First Time Home Buyers.

 

What Debt To Income Ratio I Need To Buy a Home – Conclusion

 

Now that you learned about “What debt to income ratio do I need to buy a home?”, let’s sum it up:

• A Debt-to-Income (DTI) Ratio measures your ability to repay money borrowed on a monthly basis for a home mortgage;
• The DTI calculates your debt-to-income ratio by totaling your recurring monthly debts and dividing them by your gross monthly income;
• The lower your DTI ratio, the easier it is to qualify for a mortgage at a low-interest rate; and
• A good Debt-to-Income (DTI) Ratio for a mortgage is lower than 36%. Also, only 28% or less must service your mortgage.

If you don’t meet this limit, you need to do one option (or a combination of the two) to lower your debt-to-income (DTI) ratio:

1. Reduce your monthly recurring debt; and/or
2. Increase your gross monthly income.

In addition, lenders examine your credit score which includes your credit usage ratio (debt-to-credit ratio). This includes totaling all your credit card balances with the total credit limits. The closer you get to maxing out your credit limits, the lower the score.

 

Looking to Buy a Home in San Diego County?

 

Big Block Realty provides experienced Realtors to help you find the right home in the greater San Diego area. Also, we can introduce you to mortgage lenders to assist you with qualifying for a loan.

Contact us before you begin searching for your new home in San Diego where we can help you find your dream home at an affordable price.

 

 

Steven Rich, MBA – Guest Blogger

 

 

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