When you’re applying for a mortgage, one of the first steps a lender will take is to review your credit reports from the three major national credit bureaus: Experian™, Equifax®, and TransUnion®. These reports outline your outstanding loan balances, credit cards, and other financial obligations.
Your lender will carefully consider these debts when determining your ability to repay a mortgage. The debts listed on your credit reports will help the lender calculate what size mortgage you can afford and what your monthly payment will look like.
What Debts Appear on Your Credit Report?
Several major financial obligations show up on your credit reports, and they all factor into your mortgage application. Here’s a breakdown of the common debts lenders will consider:
- Mortgage or Rent Payments
- If you currently own a home, your mortgage (including any second mortgages or home equity loans) is likely your largest monthly debt. When applying for a new mortgage, your lender will include your estimated new mortgage payment in their calculations.
- Loan Payments
- Any recurring loan payments you make, such as those for auto loans, student loans, or personal loans, are considered part of your debt. These are important for your lender to assess your overall financial health and determine what you can afford.
- Credit Card Payments
- Your credit card balances and the minimum monthly payments on each card are also included in your total debt. For instance, if you have three credit cards with minimum payments of $100, $50, and $45, your lender will count $195 as part of your monthly debt.
- Alimony and Child Support Payments
- If you’re divorced and make monthly alimony or child support payments, these too are considered part of your financial obligations. These payments must be accounted for even if you’re adding a new mortgage payment.
The Debt-to-Income (DTI) Ratio: What It Means for You
One of the key figures a lender looks at when determining your mortgage eligibility is your debt-to-income (DTI) ratio. This ratio shows how much of your gross monthly income goes toward paying off your debts. Most lenders prefer your DTI to be no higher than 43%, which helps ensure you can comfortably manage your mortgage payments in addition to other financial responsibilities.
To calculate your DTI ratio, follow these steps:
- Calculate Your Gross Monthly Income
- This is your total monthly income before taxes, including salary, Social Security benefits, disability payments, and other consistent monthly income sources.
- Add Up Your Monthly Debts
- Include all recurring payments like credit card bills, auto loans, student loans, and your estimated new mortgage payment.
- Divide Your Debts by Your Gross Income
- For example, if your gross monthly income is $7,000 and your total monthly debts (including your new mortgage payment) are $3,000, your DTI ratio would be 43%.
By either increasing your income or reducing your existing debts, you can improve your DTI ratio, which might help you qualify for a larger loan.
How Your Debt Affects Mortgage Approval
Your DTI ratio plays a crucial role in determining whether you qualify for a mortgage. If your ratio is too high, lenders may be hesitant to approve your loan, fearing that you may struggle to make payments. Additionally, a high DTI could limit the amount of the loan you’re eligible for.
On the flip side, a lower DTI ratio makes you a more attractive candidate for a mortgage. The lower your DTI, the greater the chance you’ll qualify for favorable loan terms, including lower interest rates and higher loan amounts.
Here’s a breakdown of how different types of loans might be affected by your DTI:
- Conventional Loans: Offered by private lenders, these loans may require as little as a 3% down payment. A strong credit score (typically 740 or higher) and a low DTI will help you secure the best rates.
- FHA Loans: These loans, insured by the Federal Housing Administration, require just a 3.5% down payment for those with a credit score of at least 580. If your DTI is low, you’ll be more likely to qualify.
- VA Loans: Available to military service members and veterans (and their widows), VA loans require no down payment and are more lenient about DTI ratios.
- USDA Loans: These are available for homes in rural areas and also don’t require a down payment. However, they come with more specific eligibility criteria.
- Jumbo Loans: If you need a loan above the standard limit (often over $766,550, depending on your location), a jumbo loan may be necessary. These loans usually require excellent credit and a low DTI to secure favorable terms.
How Much Debt Can You Have and Still Get a Mortgage?
Each lender has different criteria, but most prefer that your total monthly debt, including your mortgage payment, doesn’t exceed 43% of your gross monthly income. Staying under this threshold can improve your chances of approval and potentially qualify you for better loan terms.
What Debt Is Included in Your DTI?
Lenders calculate your DTI based on debts that require monthly payments. These include:
- Mortgage or rent payments
- Car loans
- Student loans
- Credit card payments (minimum required)
- Personal loans
- Alimony or child support payments
What Is Not Included in Your DTI?
Some expenses won’t factor into your DTI ratio. These include:
- Medical debts
- Utility bills (like electricity, water, etc.)
- Cell phone or cable bills
- Car insurance or health insurance
Take the First Step Towards Your Mortgage
Understanding how your debts factor into your mortgage application is key to making informed decisions. At AvantiWay Financial, we’re here to guide you through the process and help you explore your mortgage options. Whether you’re a first-time homebuyer or refinancing, we’re ready to assist you in securing the right mortgage for your financial situation.
If you’re ready to take the next step, apply online today for expert recommendations with real interest rates and personalized payment options!
