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If you need to obtain mortgage buy one housemake sure your finances are in good shape—especially your debt to income ratio.
Your debt-to-income ratio is all your monetary debt payments divided by your gross monthly income. This is the lender’s “first way” to measure your ability to manage your monthly loan repayments, Every Consumer Financial Protection Bureau.
Debt-to-income ratio is the most common reason for mortgage application rejection at 40%, according to See the 2024 Home Buyer and Seller Profile report from the National Association of Realtors.
The report found that other factors affecting homebuyers’ approval process include low credit scores (23%), unverifiable income (23%) and insufficient reserves (12%).
The NAR survey of 5,390 buyers who purchased a primary residence between July 2023 and June 2024 found that 26% of homebuyers paid all cash, a new high.
Lenders seek ‘healthy’ debt-to-income ratios
The trend has been fueled by repeat homebuyers who have experienced record home equity in recent years, according to the National Association of Realtors.
But for those who need to borrow money to buy a home, lenders and institutions will look at your debt-to-income ratio to see if you might have difficulty increasing your mortgage payments on top of your other debt obligations.
“The higher your debt-to-income ratio, the less likely they are to be willing to lend to you,” says Clifford Cornell, a certified financial planner and associate financial advisor at Bone Fide Wealth in New York City.
Shweta Lawande, a certified financial planner and principal advisor at Francis Financial in New York City, says this is a factor that affects homebuyers of all income levels.
“If you’re a high-income earner, you may not have a problem saving for a down payment, but that doesn’t mean you have a healthy debt-to-income ratio,” she said.
Here’s what you need to know about debt-to-income ratios.
How to calculate your debt-to-income ratio
Lawande says if you want to apply for a mortgage, the first step is to know what your current DTI ratio is.
Calculate the total monthly payment you need on a debt, such as a monthly student loan or car loan payment. Divide that amount by your total monthly income, she says. Multiply the result by 100 to get the DTI expressed as a percentage.
A DTI ratio of 35% or less is generally considered “good” according to Go to the loan tree.
But Brian Nevins, sales manager at Redfin-owned mortgage lender Bay Equity, said sometimes lenders can be flexible and approve applicants with debt-to-income ratios of 45% or higher. recent told CNBC.
One way to calculate your housing budget is what’s called 28/36 rule. The guidelines state that you should spend no more than 28 percent of your gross monthly income on housing expenses and 36 percent of your gross income on all debt obligations.
For example: If someone’s gross monthly income is $6,000 and their monthly payment is $500, they can afford a mortgage of $1,660 per month if they follow the 36% rule. If the lender accepts a DTI of up to 50%, the borrower can pay $2,500 per month on the mortgage.
“That’s really the maximum amount that most loan programs can get approved for,” Nevins said. Tell CNBC.
“Better” Debt Repayment Strategies
You can improve your debt-to-income ratio by reducing existing debt or increasing your income.
If you have existing debt, you have two ways Experts say you can pay it off through work: the so-called “snowball method” and “avalanche method”.
The snowball method is to pay off the smallest debt balance first, regardless of the interest costs, so it doesn’t feel as overwhelming, said Shaun Williams, a private wealth advisor and partner at Paragon Capital Management in Denver. No. 38 firmly CNBC 2024 Financial Advisor Top 100 List.
“One is what’s best on a spreadsheet, and the other is what feels best from a behavioral finance perspective,” Williams said.
However, “Avalanche is better because the real cost of debt is your interest rate,” he said, because you’re more likely to pay it off faster.
Let’s say you have student loans 6% interest rate Compared to existing credit card balance 20% interest rate. Cornell says if you’re carrying credit card debt, consider addressing that issue first.
“Whichever loan costs the most, you want to pay it off as quickly as possible,” he said.
If you’ve done everything you can to consolidate or eliminate existing debt, focus on increasing your income and avoid other large purchases that require financing, Lavande says.
“Our goal is to preserve cash flow as much as possible,” she said.
