There's a lot that goes into the home buying process, especially if you're a first-time home buyer. One criteria mortgage lenders use to assess your mortgage application is thedebt-to-income ratio (DTI). Your debt-to-income ratio is a comparison of how much you owe (your debt) to how much money you earn (your income). The income you make before taxes (your gross income) is used to measure this number.
A lower debt-to-income ratio tells lenders you have a healthy balance between debt and income. However, a higher debt-to-income ratio indicates that too much of your income is dedicated to paying down debt. This could make some lenders see you as a risky borrower. While the DTI isn't the only factor used to assess how much you can borrow, it's still important to understand before you begin the home loan process.
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What is a good debt-to-income ratio?
A debt-to-income ratio of 20% means that 20% of your income is going toward debt payments. This includes cumulative debt payments, so think credit card payments, car payments, student loans, personal loans and any other debt you may have taken on.
According to a breakdown fromThe Mortgage Reports, a good debt-to-income ratio is 43% or less. Many lenders may even want to see a DTI that's closer to 35%, according to LendingTree. A ratio closer to 45% might be acceptable depending on the loan you apply for, but a ratio that's 50% or higher can raise some eyebrows.
Simply put, having too much debt relative to your income will make it harder to qualify for some home loans. That's why many common forms of debt — like student loan debt or credit card debt —can be a major barrier to homeownership.
Mortgage lenders want to make sure borrowers haven't overextended themselves in terms of how much debt they can afford to take on. This is why having a high DTI could cause lenders to decline your mortgage application.
How do you calculate debt-to-income ratio?
The formula for calculating your DTI is actually pretty simple: You'll just need to add up your total monthly debt payments and divide it by your total gross monthly income.
Let's say you have a student loan payment, a car payment and a credit card payment that total to $1,000 per month. Your gross monthly income is $5,000. When we divide 1,000 (your debt) by 5,000 (your gross income), we get 0.2, which is 20%. So in this case, your DTI is 20%.
How do you lower your debt-to-income ratio?
If you're worried that your high DTI may prevent you from getting your desired home loan, you can try to lower it before beginning the mortgage application process. Usually, this means either paying down your debt or increasing your income.
If you have credit card debt spread among multiple cards, using a debt consolidation personal loan can help you organize all those payments into just one monthly payment at a potentially lower interest rate. This helps you pay down the balance faster since you're saving on interest. Select ranked the Happy Money personal loan as one of the best for debt consolidation since it allows you to use the funds to pay creditors directly.
Happy Money
Annual Percentage Rate (APR)
11.72% - 17.99%
Loan purpose
Debt consolidation/refinancing
Loan amounts
$5,000 to $40,000
Terms
2 to 5 years
Credit needed
Fair/average, good
Origination fee
0% to 5% (based on credit score and application)
Early payoff penalty
None
Late fee
5% of monthly payment amount or $15, whichever is greater (with 15-day grace period)
Terms apply.
Alternatively, you might consider using a balance transfer credit card to move your balance over to a new card with a 0% intro APR offer. This way, you can have an extended period where you aren't being charged interest on your payments and can pay down the principal debt faster.
TheCiti Simplicity® Cardoffers a 0% intro APR for 21 months on balance transfers from the date of your first transfer (after, 19.24% - 29.99% variable APR; balance transfers must be completed within four months of account opening).
Citi Simplicity® Card
On Citi's Secure Site
Rewards
None
Welcome bonus
None
Annual fee
$0
Intro APR
0% Intro APR for 21 months on balance transfers from date of first transfer and 0% Intro APR for 12 months on purchases from date of account opening.
Regular APR
19.24% - 29.99% variable
Balance transfer fee
There is an intro balance transfer fee of 3% of each transfer (minimum $5) completed within the first 4 months of account opening. After that, your fee will be 5% of each transfer (minimum $5).
Foreign transaction fee
3%
Credit needed
Excellent/Good
See rates and fees. Terms apply. Read our Citi Simplicity® Card review.
Another solid option is theWells Fargo Active Cash® Card. It offers a 0% intro APR for 15 months from account opening on purchases and qualifying balance transfers. 20.24%, 25.24%, or 29.99% Variable APR thereafter; balance transfers made within 120 days qualify for the intro rate and fee of 3% then a BT fee of up to 5%, min: $5. In addition, this card offers a welcome bonus: you can earn $200 cash rewards bonus after spending $500 in purchases in the first three months.
Wells Fargo Active Cash® Card
On Wells Fargo's secure site
Rewards
Unlimited 2% cash rewards on purchases
Welcome bonus
Earn a $200 cash rewards bonus after spending $500 in purchases in the first 3 months
Annual fee
$0
Intro APR
0% intro APR for 15 months from account opening on purchases and qualifying balance transfers; balance transfers made within 120 days qualify for the intro rate
Regular APR
20.24%, 25.24%, or 29.99% Variable APR
Balance transfer fee
3% intro for 120 days from account opening then BT fee of up to 5%, min: $5
Foreign transaction fee
3%
Credit needed
Excellent/Good
See rates and fees, terms apply.
Mortgages and DTI
When applying for a mortgage, you should also consider all the costs that come with purchasing a home, including private mortgage insurance (PMI) (if you put down less than 20%, homeowner's insurance), property taxes, interest, lender fees, inspections, appraisals, closing costs and more.
Needless to say, it's an expensive process. But you can make it a little more affordable by choosing a lender that offers ways to help you save. For example, Ally Bank doesn't charge certain lender fees such as an application fee, origination fee, processing fee or underwriting fee. This can help you save some cash on the upfront process.
Ally Home
Annual Percentage Rate (APR)
Apply online for personalized rates; fixed-rate and adjustable-rate mortgages included
Types of loans
Conventional loans, HomeReady loan and Jumbo loans
Terms
15 – 30 years
Credit needed
620
Minimum down payment
3% if moving forward with a HomeReady loan
Terms apply.
Pros
- No lender fees
- Preapproval in as little as three minutes
- Available in all 50 states
- HomeReady loan only requires a 3% down payment
Cons
- No FHA, USDA or VA loans
- No home equity line of credit (HELOC) loans
- No physical branches
PNC Bank also offers a few specialized loan options designed to help certain members of the community save money on their home purchase. This lender offers a loan option for medical professionals who are looking to buy a primary residence only. With this loan, medical professionals can apply for as much as $1 million and won't have to pay private mortgage insurance (PMI), regardless of their down payment amount.
PNC Bank
Annual Percentage Rate (APR)
Apply online for personalized rates; fixed-rate and adjustable-rate mortgages included
Types of loans
Conventional loans, FHA loans, VA loans, USDA loans, jumbo loans, HELOCs, Community Loan and Medical Professional Loan
Terms
10 – 30 years
Credit needed
620
Minimum down payment
0% if moving forward with a USDA loan
Terms apply.
Pros
- Offers a wide variety of loans to suit an array of customer needs
- Available in all 50 states
- Online and in-person service available
Cons
- Doesn't offer home renovation loans
Bottom line
Taking on a mortgage is a hefty responsibility, so lenders want to make sure you aren't biting off more than you can chew when it comes to your current debt responsibilities. This is why they calculate a debt-to-income ratio to judge how much of your income goes toward debt payments.
Of course, the DTI isn't the only criteria a lender will look at, so don't feel too discouraged if your DTI is a little higher than most lenders prefer. Calculating your DTI sooner rather than later will allow you ample time to pay down debt or increase your income so you can lower that DTI.
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Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.
