Understanding Debt-to-Income Ratio for Homebuyers

Buying a home is one of the biggest financial steps you can take. While the entire process is layered, there’s one substantial piece to take note of when looking at your mortgage loan opportunities: Your debt-to-income ratio.

What is Debt-to-Income Ratio?

In the simplest terms, your debt-to-income ratio (DTI) is how much debt you carry in relation to your income. From the perspective of a lender, your DTI helps determine your creditworthiness, or ability to take on more debt. Oftentimes, a high DTI indicates financial strain, and lenders may be hesitant to approve an application due to a high DTI.

How to Calculate Your Debt-to-Income Ratio

One of the easiest ways to calculate your DTI is to use a DTI calculator. Many lenders offer their own version of these tools, but you can also calculate your DTI using the following formula:

Total monthly debt payment / gross monthly income x 100

An example of a DTI calculation would be as follows: Say your monthly payments toward debt total $1,000, and your gross monthly income is $4,500. The formula for your DTI would be:

1,000 / 4,500 x 100 = 22%

Most experts recommend keeping a DTI of under 36%, but some mortgage lenders may allow for a DTI up to 45%. 

How Your Debt-to-Income Ratio Affects Mortgage Qualification

A high debt-to-income ratio could make it harder to qualify for a mortgage loan, particularly a loan with a good interest rate. A higher interest rate often translates to a more expensive loan, but a good DTI can increase your chances of securing a mortgage loan with more favorable terms. 

Some mortgage lenders have DTI requirements for approval, so if your DTI surpasses that threshold, you may not be able to secure the loan.

Mortgage Approval Tips

Mortgage approval is possible, even if you're still working to improve your DTI. Here are some of the top tips for getting approved for a mortgage loan:

• Pay Down Debts. A better DTI could mean a better mortgage rate. Show lenders you have solid management over your finances by paying off as much debt as you can before buying a home.
• Check Your Credit Profile. Errors on your credit report may affect your ability to secure approval for new credit. Something as small as a missing initial in your name can have an impact. Set yourself up for success by ensuring your credit profile is accurate and up-to-date. You can get one free credit report from each of the three credit bureaus each year at AnnualCreditReport.com.
• Boost your savings. The cost of a home is more than just the value of the house itself. You’ll also need money for a down payment, closing costs, and other moving expenses (think movers, packing supplies, moving trucks, gas, etc.)
• Pick the Right Type of Mortgage. A mortgage comes in many shapes and sizes. You can choose between a fixed-rate and an adjustable-rate mortgage (ARM). Conventional loans, USDA loans, FHA Loans, and VA loans are just a few examples of different loan types for you to consider. Each one has its own set of requirements you’ll need to meet, so it’s important to do your research and apply to the one that fits best into your life.
• Shop Lenders. Not every mortgage lender is made equal, so you’ll want to take a closer look at each one to find the right fit. Lenders can offer different rates, extras, or have different approval requirements. 
• Seek Preapproval. Pursuing preapproval can give you better insight into your likelihood of approval for a mortgage loan. It can also give you a better idea of what your rate could look like from a given lender. 

Bottom Line

Your debt-to-income ratio can be a key player in determining the types of mortgage loans you can get and how much they can cost over time. As you plan to purchase your new home, calculate your DTI and use it to establish a better understanding of your total financial picture.

A semi-custom build with True Homes can offer you flexibility, affordability, and comfort all around. With homes ranging from $200K to $700K, a True Home may be just the thing you need to strike the right balance between a personalized home that’s true to you and a home that you can afford. If you’re ready to learn more, we’re ready to help you find your perfect fit.