The debt-to-income ratio is one of the most important factors mortgage lenders use to evaluate the creditworthiness of borrowers. It measures the size of your monthly debt burden relative to the size of your monthly pay. And in addition to your credit score and other financial information, it helps lenders decide whether you’re capable of taking on another loan. Worried that you have too much debt to buy a house? Let’s look at what lenders have to say about the ideal debt-to-income ratio for mortgages.
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Calculating the Debt-to-Income Ratio
You can calculate your debt-to-income ratio by dividing your recurring monthly debt obligations (such as your minimum credit card payments, student loan payments and child support payments) by your gross (pre-tax) monthly income. When your lender calculates it, that percentage will include your potential mortgage debt burden.
The debt-to-income ratio gives lenders an idea of how you’re managing your debt. It also allows them to predict whether you’ll be able to pay your mortgage bills.
It’s important to note that debt-to-income ratios don’t consider the amount of money you’re using to pay for living expenses. In other words, things like car insurance payments, entertainment expenses and the cost of buying groceries are not included in the ratio. Even if you think you can afford to take on a mortgage, you’ll need to figure out how that’ll affect your entire budget.
The Maximum Debt-to-Income Ratio for Mortgages
Currently, the maximum debt-to-income ratio that a homebuyer can have is 43% if he or she wants to take out a qualified mortgage. Qualified mortgages are home loans with certain features that ensure that buyers can pay back their loans. For example, qualified mortgages don’t have excessive fees. And they help borrowers avoid loan products – like negatively amortizing loans – that could leave them vulnerable to financial distress.
Banks want to lend money to homebuyers with low debt-to-income ratios. Any ratio higher than 43% suggests that a buyer could be a risky borrower. To a lender, someone with a high debt-to-income ratio can’t afford to take on any additional debt. And if the borrower defaults on his mortgage loan, the lender could lose money.
The Ideal Debt-to-Income Ratio for Mortgages
While 43% is the highest debt-to-income ratio that a homebuyer can have, buyers can benefit from having lower ratios. The ideal debt-to-income ratio for aspiring homeowners is at or below 36%.
Of course the lower your debt-to-income ratio, the better. Borrowers with low debt-to-income ratios have a good chance of qualifying for low mortgage rates.
Mortgage lenders want potential clients to be paying off a small amount of debt relative to their monthly income. If you’re trying to qualify for a mortgage, it’s best to keep your debt-to-income ratio below 36%. That way, you’ll improve your odds of getting a mortgage with better loan terms.
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