Advertiser Disclosure

Life Events, Mortgage

Debt-To-Income and Your Mortgage: Will You Qualify?

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

Disclosure : By clicking “See Offers” you’ll be directed to our parent company, LendingTree. Based on your creditworthiness you may be matched with up to five different lenders.

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%.

LendingTree

SEE OFFERS Secured

on LendingTree’s secure website

NMLS #1136 Terms & Conditions Apply

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 TypeDebt-to-Income Ratio
Conventional loan43%; up to 50% with compensating factors.
FHA loan43%; up to 50% with compensating factors.
VA loanNo DTI max, but there’s a residual income test.
USDA loan41%; 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.

LendingTree

SEE OFFERS Secured

on LendingTree’s secure website

NMLS #1136 Terms & Conditions Apply

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.

FHA Mortgage

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.
What Mortgage Amount Do you Need?
Calculate Payment Secured

on LendingTree’s secure website

 

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.

This article contains links to LendingTree, our parent company.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Crissinda Ponder
Crissinda Ponder |

Crissinda Ponder is a writer at MagnifyMoney. You can email Crissinda here

Compare Mortgage Loan Offers for Free

Home Purchase Quotes

Home Refinance Quotes

(It only takes 3 minutes!)

NMLS #1136 Terms & Conditions Apply

Advertiser Disclosure

Mortgage

Should You Save for Retirement or Pay Down Your Mortgage?

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

Getty Images

On the list of financial priorities, which comes first — paying off your mortgage or saving for retirement? The answer isn’t simple. On one hand, owning a home with no mortgage attached to it provides long term security knowing you’ll have a place to live with no monthly payment except property taxes and insurance. However, you’ll also need income to live on if you plan to retire, and how much you save now will have a big impact on your quality of retirement life.

We’ll discuss the pros and cons of whether you should save for retirement or pay down your mortgage, or maybe a combination of both.

Pros of paying down your mortgage vs. saving for retirement

The faster you pay your mortgage off, the sooner you own the home outright. However, there are other benefits you’ll realize if you take extra measures to pay your loan balance off faster.

You could save thousands in long-term interest charges

Most homeowners take out a 30-year mortgage to keep their monthly payments as low as possible. The price for that affordable payment is a big bill for interest charged over the 360 payments you’ll make if you’re in your “forever” home.

For example, a 30-year fixed $200,000 loan at 4.375% comes with a lifetime interest charge of $159,485.39. That’s if you never pay a penny more than your fixed mortgage payment for that 30-year period. Using additional funds to pay down your mortgage faster can significantly reduce this.

Even one extra payment a year results in $27,216.79 in interest savings on the loan we mentioned above. An added bonus is that you’ll be able to throw your mortgage-free party four years and five months sooner.

You’ll build equity much faster

Thanks to a beautiful thing called amortization, lenders make sure the majority of your monthly mortgage payment goes toward interest rather than principal in the beginning of your loan term. Because of that, it’s difficult to make a real dent in your loan principal for many years. You can, however, counteract this by making additional payments on your mortgage and telling the lender to specifically put those payments toward your principal balance instead of interest.

Not only do you pay less interest over the long haul with this strategy, but you build the amount of equity you have in your home much faster. And to homeowners, equity is gold — you’re closer to owning your home outright, and equity can also be a resource if you need funds for a home improvement project or another big expense.

You can access that equity as your financial needs change by doing a cash-out refinance or by taking out a home equity loan or home equity line of credit (HEL or HELOC).

You won’t lose your home if values drop

When you contribute extra money into a retirement account, there is always the risk that you’ll lose some or all of the money you invested. When you contribute money to paying off your mortgage, even if the values drop, you still have the security of a place to live, and are increasing the equity in the home, no matter how much it’s ultimately worth.

Making extra payments ensures you’ll eventually have a debt-free asset that provides shelter to you and your family, regardless of what happens to the housing market in your neighborhood.

Cons of paying down your mortgage vs. saving for retirement

There are some cases where paying down your mortgage faster might actually hurt you financially. Before adding extra principal to your mortgage payments, you’ll want to make sure you aren’t doing damage to your financial outlook with an extra contribution toward your mortgage payoff.

You might end up paying more in taxes

The higher interest payments you make during the early years of your mortgage can act as a tax benefit, so paying the balance down faster could actually result in you owning more in federal taxes. If you are in a higher tax bracket in the early (first 10 years) of your mortgage repayment schedule, it may make sense to focus extra funds on retirement savings, and let your mortgage interest deduction work for you. Of course, everyone’s tax situation is different, so you’ll have to decide (with help from an accountant ideally) if it makes sense to itemize your taxes in order to claim mortgage interest payments as a deduction.

You won’t get to enjoy the return on your paydown dollars until you sell

The only real benchmark for figuring out the value of paying down your mortgage is to look at how much equity you’re gaining over time. However, the equity doesn’t become a tangible profit until you actually sell your home. And the costs of a sale can take a big bite out of your equity because sellers usually pay the real estate agent fees.

Home equity is harder to access

The only way to access the equity you’ve built up is to borrow against it, or sell your home. Borrowing against equity often requires proof of income, assets and credit to confirm you meet the approval requirements for each equity loan option. If you fall on hard financial times due to a job loss, or are unable to pay your bills and your credit scores drop substantially, you may not be able to access your equity.

Pros of saving for retirement vs. paying down your mortgage

Depending on your financial situation and savings habits, it may be better to add extra funds monthly to your retirement account than to pay down your mortgage. Here are a few reasons why.

You may earn a higher return on dollars invested in retirement funds

The growth rate for a stock portfolio has consistently returned more than housing price returns. The average return in the benchmark S&P stock fund is 6.595% for funds invested from the beginning of 1900 to present, while home values have increased just 0.1% per year after accounting for inflation during that same time period.

Assuming your portfolio at least earns 7%, if you consistently invest your money into a balanced investment portfolio, you can expect to double your money every 10 years. There aren’t many housing markets that can promise that kind of growth.

Retirement funds are generally easier to access than home equity

Retirement funds often give you a variety of options for each access, with no income or credit verification requirements, and only sufficient proof of enough funds in your account to pay it back over time. For example, a 401k loan through the company you work for will just require you to have enough vested to support the loan request, and sufficient funds left over to pay it off over a reasonable time.

Just be cautious about making a 401k withdrawal, which is treated totally differently than a loan. You aren’t expected to pay it back like you would a 401k loan, but you could get hit with taxes and penalties.

Cons of saving for retirement vs. paying down your mortgage

You’ll need to weather the ups and downs of the market

Most people who have invested money in the stock market or tracked the performance of their 401k over decades have stories about periods when the value of those investments dropped substantially. While the 7% return on investment is a reliable long term indicator how much your retirement fund might earn, the path to that return is hardly linear.

For example, if you were considering retirement between 1999 and 2002, you may have had to delay those plans when the S & P plummeted over 23% in value in 2002. If you look at each 10-year period since the 1930s, every decade has been characterized by periods of ups and downs.

Calculating the benefit of paying down your mortgage vs. saving for retirement

If you’re torn as to what to do with that extra cash or windfall, let’s look at an example of someone who has an extra $200 to put into either their nest egg or their mortgage each month for the next 30 years.

For this scenario, we’re going to assume their retirement account earns an average 7% rate of return and that their mortgage loan balance is $200,000.

Here’s how much they’d save:

Savings From Paying $200 per Month Down on Your Mortgage
Years PaidMortgage Interest SavingsExtra Equity in HomeTotal Interest Savings and Equity Built Up
10 years$6,040$30,039$36,079
20 years$28,529$76,529$105,058
22 years 6 months$50,745$200,000$250,745

One thing you may notice about the mortgage savings chart — it includes how much extra equity you’re building. Often only the mortgage interest savings is cited when people look at how much you save with extra payments, but that ignores the fact that you’re building equity in your home much faster as well. So not only do you save over $50,000 in interest with your extra contribution, you replenish $150,000 of equity that was used up by your mortgage balance.

As you can see, adding that extra $200 to their mortgage principal each month saved them about $200,000 in the long haul — but the real savings don’t stop there.

By adding an extra $200 to their mortgage payment each month, this borrower turned their 30-year loan into a 22-and-a-half year loan and became mortgage debt-free seven years faster.

That means, in addition to saving $50,000 in interest savings and gaining $200,000 of equity, they also no longer have a mortgage payment. That frees up $998.57 per month that they can now use as discretionary income. That’s an extra $89,871 they could potentially save over that 7.5 year period.

When you add that to the $250,745.41 they saved on mortgage interest and earned in home equity, they’re looking at a total savings of $340,616.

That gives the mortgage paydown a $54,000 net positive edge over saving that extra $200 for retirement, as you can see in the table below.

Savings From Contributing $200 per Month to a Retirement Fund
Years PaidRetirement Balance
10 years$34,404
20 years$102,081
30 years$235,212

The one caveat for this retirement calculation is we assumed the saver was starting at a $0 investment balance. If they already had a healthy balance in their nest egg, they might actually come out in better shape than paying down their mortgage.

There are clearly benefits to each option, and you should consider running your own calculations with your real numbers to get the best answer for yourself.

Paying down your mortgage and saving for retirement at the same time

There’s a fair case to be made for both paying down your mortgage and saving more for retirement, but why choose? If you’re somewhat on track with your retirement savings goals, and like the idea of having your mortgage paid off quicker, you could allocate a certain amount to each.

Pick a number you feel comfortable paying to your principal every month, and then to your 401k, and put it on autopilot for a year. Any time your income increases, or you get bonuses, divide up the amount between principal pay down and retirement additions.

Let’s look at what happens if you evenly divide up your $200 per month between investing your retirement and paying down your mortgage. We’ll use the same $200,000 loan at 4.375% referenced above, and look at the lifetime results.

Savings From Paying $100 Down on Your Mortgage Until Paid Off
Years PaidInterest SavingsExtra Home EquityTotal Interest Savings and Equity Built Up
10 years$3,020$15,020$18,040
20 years$14,265$38,265$52,350
25 years$30,534$200,000$230,534
Savings From Contributing $100 to a Retirement Fund for 30 Years
Years PaidRetirement Balance
10 years$17,202
20 years$51,401
30 years$117,607

Balancing the $100 investment in both strategies still yields a six-figure retirement balance after 30 decades, a debt-free house after 26 years, and shaves off $30,000 in mortgage interest expense. If you don’t like putting all your eggs into one financial basket, this may balance the risks and rewards of each option.

Final thoughts

Looking at the short term and the long term may provide you with the best framework for making a good decision about how to spend dollars on retirement versus extra mortgage payments. Be wary of any financial professional that tells you one path is absolutely better than another.

Having a stable source of affordable shelter is equally as important as having enough income to live when you retire, so a balanced approach to paying down your mortgage and savings for retirement may help you accomplish both goals.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Denny Ceizyk
Denny Ceizyk |

Denny Ceizyk is a writer at MagnifyMoney. You can email Denny here

Compare Mortgage Loan Offers for Free

Home Purchase Quotes

Home Refinance Quotes

(It only takes 3 minutes!)

NMLS #1136 Terms & Conditions Apply

Advertiser Disclosure

Life Events, Mortgage

What Is Mortgage Amortization?

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

Getty Images

One of the biggest advantages of homeownership versus renting is each mortgage payment gradually pays off your mortgage and builds equity in your home. The difference between your home’s value and the balance of your loan is home equity, and your equity grows with each payment because of mortgage amortization.

Understanding mortgage amortization can help you set financial goals to pay off your home faster or evaluate whether you should refinance.

What is mortgage amortization?

Mortgage amortization is the process of paying off your loan balance in equal installments over a set period. The interest you pay is based on the balance of your loan (your principal). When you begin your payment schedule, you pay much more interest than principal.

As time goes on, you eventually pay more principal than interest — until your loan is paid off.

How mortgage amortization works

Understanding mortgage amortization starts with how monthly mortgage payments are applied each month to the principal and interest owed on your mortgage. There are two calculations that occur every month.

The first involves how much interest you’ll need to pay. This is based on the amount you borrowed when you took out your loan. It is adjusted each month as your balance drops from the payments you make.

The second calculation is how much principal you are paying. It is based on the interest rate you locked in and agreed to repay over a set period (the most popular being 30 years).

If you’re a math whiz, here’s how the formula looks before you start inputting numbers.

Fortunately, mortgage calculators do all the heavy mathematical lifting for you. The graphic below shows the difference between the first year and 15th year of principal and interest payments on a 30-year fixed loan of $200,000 at a rate of 4.375%.

For the first year, the amount of interest that is paid is more than double the principal, slowly dropping as the principal balance drops. However, by the 15th year, principal payments outpace interest, and you start building equity at a much more rapid pace.

How understanding mortgage amortization can help financially

An important aspect of mortgage amortization is that you can change the total amount of interest you pay — or how fast you pay down the balance — by making extra payments over the life of the loan or refinancing to a lower rate or term. You aren’t obligated to follow the 30-year schedule laid out in your amortization schedule.

Here are some financial objectives, using LendingTree mortgage calculators, that you can accomplish with mortgage amortization. (Note that MagnifyMoney is owned by LendingTree.)

Lower rate can save thousands in interest

If mortgage rates have dropped since you purchased your home, you might consider refinancing. Some financial advisors may recommend refinancing only if you can save 1% on your rate. However, this may not be good advice if you plan on staying in your home for a long time. The example below shows the monthly savings from 5% to 4.5% on a $200,000, 30-year fixed loan, assuming you closed on your current loan in January 2019.

Assuming you took out the mortgage in January 2019 at 5%, refinancing to a rate of 4.5% only saves $69 a month. However, over 30 years, the total savings is $68,364 in interest. If you’re living in your forever home, that half-percent savings adds up significantly.

Extra payment can help build equity, pay off loan faster

The amount of interest you pay every month on a loan is a direct result of your loan balance. If you reduce your loan balance with even one extra lump-sum payment in a given month, you’ll reduce the long-term interest. The graphic below shows how much you’d save by paying an extra $50 a month on a $200,000 30-year fixed loan with an interest rate of 4.375%.

Amortization schedule tells when PMI will drop off

If you weren’t able to make a 20% down payment when you purchased your home, you may be paying mortgage insurance. Mortgage insurance protects a lender against losses if you default, and private mortgage insurance (PMI) is the most common type.

PMI automatically drops off once your total loan divided by your property’s value (also known as your loan-to-value ratio, or LTV) reaches 78%. You can multiply the price you paid for your home by 0.78 to determine where your loan balance would need to be for PMI to be canceled.

Find the balance on your amortization schedule and you’ll know when your monthly payment will drop as a result of the PMI cancellation.

Pinpoint when adjustable-rate-mortgage payment will rise

Adjustable-rate mortgages (ARMs) are a great tool to save money for a set period as long as you have a strategy to refinance or sell the home before the initial fixed period ends. However, sometimes life happens and you end up staying in a home longer than expected.

Knowing when and how much your payments could potentially increase, as well as how much extra interest you’ll be paying if the rate does increase, can help you weigh whether you really want to take a risk on an ARM loan.

The bottom line

Mortgage amortization may be a topic that you don’t talk about much before you get a mortgage, but it’s certainly worth exploring more once you become a homeowner.

The benefits of understanding how extra payments or a lower rate can save you money — both in the short term and over the life of your loan — will help you take advantage of opportunities to pay off your loan faster, save on interest charges and build equity in your home.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Denny Ceizyk
Denny Ceizyk |

Denny Ceizyk is a writer at MagnifyMoney. You can email Denny here

Compare Mortgage Loan Offers for Free

Home Purchase Quotes

Home Refinance Quotes

(It only takes 3 minutes!)

NMLS #1136 Terms & Conditions Apply