A high debt-to-income ratio could result in your mortgage application being rejected

If you need to take out a mortgage to buy a home, make sure your financial situation is appropriate, especially your debt-to-income ratio.

Your debt-to-income ratio is your total debt payments divided by your total monthly income. According to the Consumer Financial Protection Bureau, this is the “number one” way lenders measure your ability to manage your monthly loan payments.

According to the National Association of Realtors’ 2024 Home Buyer and Seller Profile report, debt-to-income ratio was the most common reason mortgage applications were denied, at 40%.

Other factors reported by homebuyers that influenced the approval process included poor credit scores (23%), inability to verify income (23%), and insufficient funds (12%). It was revealed in the book.

NAR surveyed 5,390 buyers who purchased their primary home between July 2023 and June 2024 and found that 26% of homebuyers paid all in cash; reached an all-time high.

The trend was driven by repeat buyers who have acquired record home equity in recent years, according to NAR.

But for those who need to borrow money to buy, lenders and lenders will look at your debt-to-income ratio to determine how difficult it is to add a mortgage payment on top of other debts. Please check if.

“The higher your debt-to-income ratio, the less likely they are comfortable lending you money,” says Clifford Cornell, a certified financial planner and associate financial advisor at Born Fied Wealth in New York City. says.

Shweta Rawande, a certified financial planner and principal advisor at Francis Financial in New York City, says this is a factor that affects housing applicants of all income levels.

“If you’re a high-income earner, saving for a down payment may be fine, but that doesn’t mean your debt-to-income ratio is healthy,” she says.

Here’s what you need to know about your debt-to-income ratio.

If you’re considering applying for a home loan, Lawande says the first step is to know your current DTI ratio.

Calculate the total monthly debt payments you need, such as monthly student loan or car loan payments. Divide that amount by your gross monthly income, she said. Multiply the result by 100 to express the DTI as a percentage.

According to LendingTree, a DTI ratio of 35% or lower is typically considered “good.”

But lenders are flexible and may approve applicants with debt-to-income ratios of 45% or higher, Brian Nevins, a sales manager at Redfin’s mortgage lender Bay Equity, recently told CNBC. told.

The way to figure out your housing budget is the so-called 28/36 rule. The guidelines state that you shouldn’t spend more than 28% of your gross monthly income on housing costs, and you shouldn’t spend more than 36% of your total debt.

Example: A person with a gross monthly income of $6,000 and monthly debt payments of $500 can afford a monthly mortgage payment of $1,660 by following the 36% rule. If a lender accepts up to 50% DTI, a borrower could potentially receive a monthly mortgage payment of $2,500.

“This is actually the maximum for most loan programs that someone can be approved for,” Nevins told CNBC.

You can improve your debt-to-income ratio by reducing existing debt or increasing your income.

According to experts, if you have existing debt, there are two ways you can work towards paying it off: the so-called “snowball” method and the “avalanche method.”

Sean Williams, a private wealth advisor and partner at Paragon Capital Management (Denver), ranked 38th on CNBC’s 2024 program, explains that the snowball method is where you pay off your lowest debt balance first, no matter what the interest rate is. He says he doesn’t feel like it’s too much of a burden since he has to pay the loan back. 100 financial advisor list.

“One is what’s best on a spreadsheet, and the other is what makes someone feel best from a behavioral finance perspective,” Williams said.

Still, he says, “the avalanche is better because the real cost of debt is interest.” This is because you are more likely to be able to pay off your debt faster.

Let’s say you have a student loan that has an interest rate of 6% while your existing credit card balance has an interest rate of 20%. If you have credit card debt, consider tackling that balance first, Cornell says.

“The most expensive things to borrow are the ones you want to pay off as quickly as possible,” he said.

If you’ve already done what you can to consolidate or eliminate existing debt, Lawande says you should focus on increasing your income and avoid other large purchases that require financing.

“The goal is just to maintain cash flow as much as possible,” she said.