Why are debt-to-income ratios important?

When applying for home loans, there are many factors that lenders use to determine whether you're a qualified borrower.

In addition to checking your employment, credit history and credit score, mortgage providers will determine how your gross monthly household income compares to your current outstanding debt. Specifically, they will calculate how much of that income is used to pay those expenses by adding up all of your monthly debt payments and dividing the total by your income. This result is presented as a percentage and known as your debt-to-income (DTI) ratio.

Borrowers who have low DTIs are more likely to qualify for mortgages because they have less debt to pay each month. Lenders will see this as a sign that the addition of a home loan is manageable. If, however, you have a high DTI, you are less likely to qualify for a premium mortgage.

What DTI do you need?
Under the Dodd-Frank Wall Street Reform Act of 2010, home loan providers are required by the U.S. Consumer Financial Protection Bureau (CFPB) to offer what are known as Qualified Mortgages. One criterion of such real estate loans is that they have a DTI no higher than 43 percent. 

While this regulation may seem to exclude some borrowers and disregard other factors that could make an individual eligible for a mortgage, the Dodd-Frank Act was put in place to protect consumers from bad mortgages and help them truly determine whether they're financially prepared to own a home.

There are exceptions to the rule. Small creditors that have less than $2 billion in assets and originated no more than 500 mortgages in the past year, for example, can offer loans to borrowers with DTIs above 43 percent. The same is true of large creditors, but they are required to make a good-faith effort to comply with CFPB regulations and ensure borrowers have the ability to repay.

Dealing with DTI obstacles
If you want to calculate your DTI, you can speak with a lender or use one of many free tools available on the Internet. Based on the result, you may not feel you are qualified for a mortgage. However, you have options to address setbacks created by your debt.

The most obvious choice is to pay off your outstanding debts. If, for instance, you have a couple credit cards, consider applying for a home loan once you've paid off any remaining balances.

Are you truly ready?
Although there are ways to get a home loan with a higher DTI, you should still consider whether your finances can support another sizeable debt. You may not want to put your homebuying dreams on pause while you improve your financial situation, but it may be best to ensure you can make your mortgage payments each month.

For more information about smart ways to manage your finances, contact Landmark Bank.

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