If you’re looking for mortgage financing, you may have already come across the term debt-to-income ratio or DTI. This figure will play an important part in whether you get mortgage financing and the amount of financing that is available to you.
Comparing Debt to Income
Your DTI ratio is a comparison of your debts to your gross income. Mortgage lenders will calculate your DTI by dividing your monthly commitments by your income. Lenders have different criteria when examining a borrower’s DTI ratio for mortgage approval, but 43 percent is an industry figure that is commonly used. Research shows that a borrower with more than a 43 DTI is more likely to have trouble making monthly mortgage payments.
Because there are no single set of requirements for conventional loans, your debt-to-income ratio requirement will be subject to the lending institution’s criteria and will also be evaluated in conjunction with your overall personal financial situation. Conventional loans typically look for borrowers who have low DTI ratios, higher credit scores and better overall financial profiles and reward them with lower interest rates and better mortgage terms.
Mortgages That Consider Higher DTIs
There are those mortgage vehicles that are available for borrowers who have a larger DTI ratio. FHA loans cap DTI ratios at 57 percent and VA loans cap DTI ratios at 60 percent (sometimes lower depending on the lender). There are other mortgage lenders and investors who will consider higher debt-to-income ratios when looking at a borrower’s all-around financial picture, assets and property equity.
Good Debt Vs. Bad Debt
Lenders will look at debt closely, allowing for good debt and bad debt to be considered differently. Good debt is something that can increase net worth or debt that can generate income. Examples of these are
- Mortgages — a mortgage will convert your living expense into an asset (a home) which provides security and stability. Your home can then offer equity as the principal is paid down or value increases.
- Small business loan — a debt to start or finance an existing profitable business can increase income
- Student debt — a student loan in pursuit of education improvement can put a borrower in the position of future earning potential boost
Bad debt is debt accumulated to purchase depreciating assets. These don’t increase in value and don’t have the ability to produce income or investment income. These are
- Credit card debt — interest rates are high, and repayment is usually designed to maximize the lender’s profitability
- Automobile loans — cars depreciate and are not particularly good investments. Interest paid toward car loans makes them even worse.
- Unsecured personal loans — because of the lack of collateral, an unsecured loan typically carries a large interest payment to offset the risk to the lender.
Improve Your DTI
Your DTI ratio can have a large impact on the type of mortgage you can be approved for. Before shopping for a mortgage, you want to lower your DTI ratio as much as possible and avoid taking on more debt, making purchases on credit or opening new credit accounts.
When you are looking for mortgage advice, contact an expert Ohio mortgage broker. Liberty Capital Services can help you make sense of applying for a mortgage and answer any questions you may have. We serve Columbus and throughout the state of Ohio for any mortgage needs. Call us today for a free consultation (614) 505-0620.