Understanding Debt-to-Income Ratio for Mortgages, Part 1
There are several factors that will be assessed by mortgage lenders when you apply for a home loan, and one such factor that’s very important in nearly all cases is your level of outstanding debt. Lenders want to know that you have the ability to pay back the money borrowed in any mortgage, and one of the top methods they’ll use to determine this is comparing your level of debt with your current income to get an idea of your broad financial picture.
At Altius Mortgage and our partners at Mortgage Ogden, we’re happy to walk you through all the details you need to know here for any of our mortgage loans. The most common debt-related metric, as we just noted, relates to your income and is known simply as debt-to-income ratio (DTI) – this two-part blog will go over everything you need to know about this metric, including the kinds of debt and how they play a role, plus how you can get your DTI ratio in the optimal place before applying for a mortgage.
Debt-to-Income Ratio Basics
As the name suggests, debt-to-income ratio refers to a comparison between your total debt and your gross income. It’s generally calculated on a monthly basis, with lenders dividing your monthly debt requirements by your monthly gross income to come up with a single figure, represented in a percentage format.
Generally speaking, lenders are looking for a DTI number of 40% or under, preferably under 36% in most cases. However, another factor involved here is the type of debt taken on, of which there are several. Our next couple sections will go over these types of debt and the roles they play in this equation.
Secured Vs. Unsecured Debt
For starters, there could be a big different in how a lender views your DTI ratio depending on whether the majority of your debt is secured or unsecured. Secured debt is any that uses collateral for the loan, such as a car loan where the lender technically claims ownership on the vehicle if the borrower does not pay back the loan properly.
Unsecured debt, then, refers to debt that required no collateral. Rather, lenders offer the loan based on your word and financial ability, plus a signed agreement. Unsecured loans tend to come with higher interest rates. Generally, secured debt is considered a more robust form of debt than unsecured, and you might be able to get away with a higher DTI ratio if most of your debt is secured.
Revolving Debt
In other cases, revolving debt refers to a loan where the consumer pays a commitment fee to a lender to borrow money on an as-needed basis. On a timeline agreed upon beforehand, the borrower can take certain amounts every so often. These loans are often used by those who have a variety of unexpected expenses in their lives, offering convenience that does often come with a higher interest rate in some cases. Home equity loans and personal lines of credit often qualify as revolving debt.
For more on DTI ratio and other important factors in a mortgage application, speak to the staff at Altius Mortgage today.
