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Debt-to-income ratio (DTI): Your key to mortgage qualification

By Milo

June 6, 2023 6 min read

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Debt-to-income ratio (DTI): Your key to mortgage qualification

Imagine, after months of house hunting, you finally stumble upon your dream home. As you walk through the house, you can visualize your future, but will your financial standing support your dream? This is where understanding your Debt-to-Income ratio (DTI) becomes vital. It's a crucial financial health indicator that can either make your dream come true or postpone it. This guide will delve into the nuances of DTI and its pivotal role in qualifying for a mortgage.

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Taking a closer look at the Debt-to-income ratio (DTI)

The DTI is more than just a financial term; it's a snapshot of your financial health, highlighting the portion of your income spent on debt repayments. Calculating your DTI involves adding up all your monthly debt payments and dividing them by your gross monthly income. But what exactly constitutes 'monthly debt payments'? These debit payments can include:

  • Mortgage or rent payments
  • Minimum credit card payments
  • Car loans
  • Student loans
  • Personal loans
  • Any other recurring debts

With these in mind, it's clear that obtaining an accurate DTI requires a comprehensive view of your financial obligations.

Why does DTI matter in mortgage lending?

In mortgage lending, DTI is a trusted compass guiding lenders towards safe harbors of creditworthiness. Mortgage giants like Fannie Mae and Freddie Mac generally prefer a DTI below 43%1, as it's less risky, indicating that you have a good balance between income and debt.

However, DTI isn't a rigid yardstick. Fannie Mae, for instance, might buy mortgages with a DTI up to 50% if there are compensating factors such as a high credit score or ample reserves2. This flexibility underscores the fact that while DTI is important, it's just one piece of the mortgage qualification puzzle.

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When your DTI tips the scales: Exploring alternative loan programs

When your DTI is high, it might seem like the doors to your dream home are closing. But, alternative loan programs like bank statement loans and debt service coverage ratio (DSCR) loans can pry them back open. Bank statement loans, for instance, are perfect for self-employed individuals or freelancers. Lenders consider bank statements instead of traditional income documentation, giving those with high DTI a fair shot at securing a mortgage3.

On the other hand, DSCR loans focus on the property in question rather than the borrower. If the property can generate enough income to cover the mortgage payment, a high DTI may be overlooked4.

Sculpting your DTI for improved mortgage chances

Improving your DTI can be a game-changer in your mortgage application process. A 2019 Experian study revealed that consumers with lower DTIs (between 5.0% to 19.9%) were significantly more likely to get a mortgage compared to those with DTIs of 40% or higher5.

A common method to improve your DTI is to follow the 28/36 rule, which suggests that no more than 28% of your gross monthly income should go towards housing expenses, and no more than 36% towards total debt service6. For example, if your gross monthly income is $6,000, following the 28/36 rule means your housing expenses should not exceed $1,680 (28% of $6,000) and total debt service should not exceed $2,160 (36% of $6,000). Following this rule can lead to a healthier DTI and increase your chances of securing a mortgage.

Charting the future of DTI in mortgage lending

As the world of mortgage lending navigates the digital transformation, the way DTI is evaluated is also evolving. Today, fintech companies and digital-first lenders have begun to supplement traditional metrics with innovative assessment methods.

While traditional banks have relied heavily on DTI, fintech is striving to consider a wider range of financial factors. For example, some digital lenders leverage data analytics to get a more comprehensive understanding of a borrower's financial situation, beyond just the DTI. This shift could potentially pave the way for more inclusive lending standards, challenging the conventional reliance on DTI alone.

Even though Milo adheres to traditional DTI evaluation, we understand that every financial situation is unique. We are committed to personalized service, walking you through the complexities of mortgage lending, and providing solutions tailored to your individual needs.

Making your dream home a reality

Understanding and effectively managing your DTI can be the key to turning your homeownership dreams into reality. It's a journey of balancing income and debt, understanding mortgage options, and keeping an eye on the evolving lending landscape.

As you embark on your home-buying journey, remember Milo is there to assist. With tailored mortgage solutions and an expert team to guide you, we are committed to making homeownership accessible and straightforward. Take the first step today by reaching out to our team or exploring our online resources, and let us help you unlock the door to your dream home.

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The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product.

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