Whether you are looking to purchase your first home or acquiring your eleventh investment property, one of the factors that can make or break any mortgage is the buyer’s debt-to-income ratio.
This is one of the key metrics that your mortgage company will be using to determine whether or not you can afford the mortgage you are applying for.
Calculating Your Debt-to-Income Ratio
Figuring out your debt-to-income ratio is actually a pretty simple process. There are some fractions involved, but don’t worry, there are also plenty of calculators available to help you if you need them!
Actually, the most complicated part of calculating your debt-to-income ratio is making sure that you are accounting for all of your debts and all of your income. The easiest way to start that process is to pull a copy of your credit report. While it’s possible to have some debt that isn’t on your credit report, most of the major relevant debts are usually there.
With your credit report in hand, you just need to add up all of your outstanding debts. This includes any existing mortgages, car loans, school loans, credit cards, and anything else that shows up as a debt on your credit report.
Take that total number that includes all of your debt and divide it by your annual gross income and you will have a good estimate of your debt-to-income ratio. It’s that easy. (Again, don’t freak out about the math…there are lots of simple calculators out there to help with this.)
What Are the Mortgage Companies Looking For?
The lower your outstanding debts are compared to your income, the better you are going to look on paper, so the mortgage companies are looking for a debt-to-income ratio as close to zero as possible. But this is the real world, so they understand that we aren’t all going to be there.
A ballpark average debt-to-income ratio that the mortgage companies are looking for is about 36%.
For most companies, the upper limit for approving a mortgage is somewhere between 37% and 40%. However, there are mortgage companies that will go as high as 45%. It is important to remember that this limit is set in stone for most mortgage companies, so if you are close to their limit, even the slightest adjustment could mean the difference between getting the mortgage or not getting it.
The Income Side
If your debt-to-income ratio is not where you want it to be, there are two ways that you can change it. The first way is to increase your income.
If you have seen small increases in your annual income over the past few years and are expecting that to continue, you might have a valid argument to support a higher income. In these cases, having your employer support you on this can be a big help.
One thing that you cannot do on the income side is add expected rental revenue if you are applying for a mortgage on an investment property.
The Debt SideYou can also lower your debt-to-income ratio by making some improvements on the debt side. This means making additional payments on fixed loans or reducing the principal owed on revolving credit.
Of course, the catch on this side is that you have to be able to reduce your debt and still have enough capital for the down payment and closing costs. For investment properties, many mortgage companies also like for you to have six months worth of payments sitting in an account.
As you might have guessed, improving your debt-to-income ratio is not a quick-fix scenario. It takes consistent effort over time to get yourself into a place where you can be looked at in a positive light when you apply for a mortgage.
However, if you are working with a good mortgage professional who understands the business, they should be happy to identify the products they offer for your debt-to-income ratio.
Your local Carrington Real Estate Services Sales Professional can actually help you find a mortgage Loan Officer as they work with them every day. Contact us today!