If you're thinking about buying a home, you might be considering your mortgage options. With so many choices and rates out there, it can be challenging to know where to start.
That's why it's important to understand your Debt-to-Income (DTI) ratio, as it plays a crucial role in determining what you'll need to qualify for a mortgage.
The Debt-to-Income ratio is a percentage used by lenders to assess your ability to handle monthly payments and repay debts. It essentially shows how much of your gross monthly income is dedicated to debt payments.
But how does it apply to your mortgage, and why does it matter? Let’s talk about it!
How is the DTI Ratio Calculated?
To calculate your DTI ratio, simply divide your total monthly debt payments by your gross monthly income. This includes payments towards credit cards, car loans, student loans, and other regular debts, along with expected mortgage and housing expenses.
For instance, if you earn $5,000 a month and your total monthly debts are $2,000, your DTI ratio would be 40% (which is calculated as $2,000 divided by $5,000, then multiplied by 100).
Give it a try, and see what your DTI ratio is!
Why is the DTI Ratio Important for My Mortgage?
There are 4 key indicators lenders use your DTI ratio for, to help them understand if you will be able to manage the mortgage amount you are applying for/have received. These indicators include:
Qualifying: Lenders assess your financial health using the DTI ratio. It is common for lenders to look for a DTI ratio of no more than 39% for total debt and 44% specifically for housing expenses. This means that your housing costs, which include mortgage payments, property taxes, and heating expenses, should not make up more than 44% of your gross income. This number helps to put into perspective if you are the right candidate for the mortgage you are applying for.
Financial Health: A lower DTI ratio indicates a healthy balance between debt and income, showing that you are financially stable. This suggests to your lender that you are less likely to encounter problems with making mortgage payments.
Interest Rates and Terms: If you have a low DTI ratio, you are often eligible for better interest rates and more favourable loan terms. Lenders will see you as lower risk, which can significantly influence the terms of the mortgage.
Mortgage Amount: Your DTI ratio directly impacts the amount you can borrow. Lenders use this ratio to determine the maximum mortgage amount you’re eligible for, based on your ability to repay.
How Can I Improve My DTI Ratio?
If you did a quick calculation and saw that your DTI ratio is higher than what lenders would prefer, here are some strategies to improve it:
Boost Your Income: Consider ways to boost your income, whether through advancing in your current job, picking up additional part-time work, or exploring passive income opportunities.
Pay Down Debts: Focus on reducing your debt levels, especially high-interest credit card debts and personal loans. This should be your first priority!
Avoid New Debt: Keep your credit inquiries and new debt acquisitions minimal in the months leading up to your mortgage application.
Better Understand Your DTI Ratio with Arise Mortgage
By understanding and improving your DTI ratio, you can boost your likelihood of mortgage approval, secure better loan terms, and maintain a manageable level of debt compared to your income.
But if you don’t know where to start, that is what we are here for!
Our team is able to guide you through the process, and find the best solution to help you reach your homeownership goals in a sustainable and confident way.
Get in touch with our team today to discover what we can do for you and your homeownership journey.
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