The most important factor in getting a mortgage probably isn’t your credit score. Your application more likely hinges on your debt-to-income ratios — crucial measures that tell lenders how well you are managing payments with your monthly earnings.
Before you take ownership of your dream home, you’ll need to prove you’re aren’t presently overwhelmed with your credit card and loan payments, and that you can comfortably repay a mortgage on top of everything else on your plate.
Keep reading to get a handle on debt-to-income ratios and why they matter so much when you’re buying a home.
Understanding debt-to-income ratios
Mortgage lenders definitely care about your credit score, but they’re even more concerned with your debt-to-income (DTI) ratio. Your DTI ratio is the percentage of your gross monthly income that is dedicated to monthly debt payments, including auto loans, credit cards, housing, personal loans, student loans and any other loans or lines of credit you’re responsible for repaying.
DTI ratios help tell lenders how much money you’ll have left over each month after you satisfy your debt obligations. It also gives them a measurement of how likely you’ll fall behind on your payments and helps them determine how much money they’ll be comfortable lending to you.
How to calculate your DTI
There are two types of DTI ratios: front-end and back-end. The front-end ratio focuses solely on your housing debt, whether it’s rent or mortgage payments. Let’s say you’re trying to get approved for a home loan that has a $1,000 monthly mortgage payment and you earn a gross monthly income of $5,000. You would divide the mortgage payment by your income amount to get a front-end DTI ratio of 20%.
The back-end ratio is more widely used. It includes all of your monthly debt obligations, including your housing payment. To continue the above example, let’s add another $1,000 to account for your auto loan, student loans and credit cards, bringing your total monthly debt payments to $2,000. That makes your back-end DTI ratio to 40%.
What DTI do you need to get a mortgage?
Generally speaking, to increase your chances of mortgage approval, try to keep your front-end debt-to-income ratio at or below 30% and your back-end DTI ratio at or below 43%. However, it’s possible to qualify with a slightly higher back-end DTI.
The average front- and back-end ratios for all loans closed during December 2018 was 26% and 39%, respectively, according to mortgage software firm Ellie Mae’s latest Origination Insight Report.
|Mortgage Type||Debt-to-Income Ratio|
|Conventional loan||43%; up to 50% with compensating factors.|
|FHA loan||43%; up to 50% with compensating factors.|
|VA loan||No DTI max, but there’s a residual income test.|
|USDA loan||41%; up to 44% with compensating factors.|
Conventional lenders usually want to see a back-end DTI ratio of 43% or less, though some lenders may approve DTI ratios of up to 50% if the borrower has a higher credit score or a larger down payment. Similar guidelines apply to FHA loans. Check out our explainer on minimum mortgage requirements for a deeper dive on the DTI requirements for additional mortgage types.
How to improve your DTI
There are a few ways to improve your debt-to-income ratio before you apply for a mortgage.
Pay down your existing debt
Take the time to chip away at your auto loan, credit card, student loan and other debt by dedicating any extra money that comes your way to that debt. Use bonuses, gifts, inheritances and tax refunds to pay down your debt balances and eventually lower the amount of your income going to debt payments every month.
Increase your income
If money is a little tight for you right now and you don’t have additional dollars to put toward paying down your debt load, consider increasing your income by picking up a side hustle, such as driving for Lyft or accepting freelance projects. Review these 10 ways to make extra money and pay off debt for more guidance.
Mortgage options for borrowers with a high DTI
It’s possible to still qualify for a mortgage if your debt-to-income ratio slightly exceeds the general requirements mentioned above. Below, we highlight a few mortgage products available to high-DTI-ratio borrowers.
Fannie Mae HomeReady® Mortgage
This low down payment loan product from government-sponsored enterprise Fannie Mae allows a maximum back-end DTI ratio of 45% for manually underwritten loans. Depending on your credit score and down payment amount, you may also need to show you have a few months of cash reserves saved up.
Freddie Mac Home Possible® Mortgage
Similar to Fannie Mae’s HomeReady® product, GSE Freddie Mac offers the Home Possible® mortgage that allows a maximum 45% DTI ratio for loans that are manually underwritten.
Home loans backed by the Federal Housing Administration allow borrowers to have DTI ratios up to 50% if they supply a down payment of at least 10%.
Other important mortgage eligibility requirements
While debt-to-income ratios can make or break a prospective borrower’s chances at buying a home, there are several other mortgage requirements that matter to the loan application process. Here’s a quick rundown of some of the most important must-haves:
- Credit score: Prepare to have a credit score of at least 620 for a conventional loan and 580 for an FHA loan. It’s possible to qualify for an FHA mortgage with a score as low as 500, but you’ll have to make a larger down payment.
- Down payment: Save for at least a 3% down payment, or higher if your credit score means you’ll need to put more money down. However, keep in mind that you’ll need to account for mortgage insurance for down payments that are less than 20%.
- Employment and income: You’ll need to have proof of a steady job and income in order to qualify for a mortgage. Gather your pay stubs and tax returns to demonstrate your capacity to take on a mortgage.
The bottom line
Mortgage lenders are tasked with establishing your ability to repay a mortgage, and that includes reviewing your existing debt load and how your hypothetical mortgage would fit into your current financial picture.
If you’re anxious about your debt-to-income ratio percentages, take action to increase the money you bring in monthly and decrease your credit card and loan balances to more manageable amounts.
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