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How Does Debt Affect Your Ability to Buy a House?

October 11, 2024
Exterior street scene of the Row Collection at New Haven in Ontario CA

Understanding your debt-to-income (DTI) ratio is an important part of your overall financial health. This simple yet powerful number shows how much income you bring in versus how much money you spend on monthly debt payments.

Lenders pay close attention to this ratio when assessing your ability to take on a new loan, especially when you’re looking to buy your dream home.

Your DTI ratio isn't just another financial number—it's a critical factor that can make or break your chances of securing a loan. Whether you're ready to buy a home or simply looking to improve your financial health, understanding your DTI ratio is essential.

We’ll walk you through how DTI is calculated, what to do if it's too high, strategies to improve it, and how it directly impacts your ability to get the loan you need.

Harvest 8 kitchen at Barefoot Lakes by Brookfield Residential in Firestone CO

Harvest Eight Floor Plan, Harvest Portfolio, Barefoot Lakes Community, Firestone, Colorado

What is debt-to-income ratio?

Your debt-to-income ratio, or DTI, is a simple way to see how much of your income is used to pay off your debts. DTI is expressed as a percentage and is calculated by determining what portion of your monthly gross income (the amount before taxes and deductions) goes towards paying off debt, such as housing payments, credit cards, and student loans.

Why is debt-to-income important?

Lenders evaluate your DTI to help determine the risk associated with you taking on another payment and gauge the likelihood that you’ll be able to pay off a new loan, given your other debt obligations. A lower DTI generally means you’re more likely to successfully manage additional debt, which makes it easier to get approved for a loan.

How do I calculate my debt-to-income ratio?

Your debt-to-income ratio compares how much you owe each month to how much you earn. Specifically, it’s the percentage of your gross monthly income (the amount before taxes) that goes towards housing, credit cards, or other debt payments.

1. Add up your monthly bills

  • Monthly housing payment (rent or mortgage including principal, interest, taxes, and insurance)
  • Monthly loan payments (student, auto, etc.)
  • Monthly alimony or child support payments
  • Credit card monthly payments (using the minimum payment amount)
  • Other debts (HELOC or lines of credit, installment loans, etc.)

Expenses like groceries, utilities, health or car insurance, and other regular monthly expenses are not typically included in the DTI calculation unless they’re part of a formal debt agreement.

2. Calculate your gross monthly income

Your gross monthly income is your total income before taxes and other deductions. If you’re salaried, it’s your annual salary divided by 12. If you have multiple income sources, add them together to get your combined gross monthly income.

3. Calculate your DTI ratio

Divide your total monthly debt payments by your gross monthly income and multiply the result by 100 to get a percentage.

How do I interpret my DTI ratio?

To put it simply, your DTI ratio is the percentage of your income that goes towards paying your debts.

Standards and guidelines will vary between lenders, but generally if your DTI ratio is:

  • Below 36%: You likely have a good balance between your debt and income. Lenders generally considered this a good ratio.
  • 36%–49%: You’re managing your debt adequately but may want to find ways to lower your DTI. Many lenders view this as an acceptable range but may scrutinize your financial situation more closely and ask for additional eligibility criteria.
  • 50% or higher: You may have limited funds to save or spend with a large percentage of your income going toward debt payments. Lenders may limit your borrowing options as you may not have much money left to save, spend, or handle unforeseen expenses.

What if my DTI ratio is too high?

The higher your DTI ratio, the more likely you are to struggle with mortgage approval and making your monthly payments. It probably makes sense to wait to make a home purchase until you’ve reduced the radio.

How can I improve my DTI ratio?

Improving your DTI ratio can be done by either reducing your debt or increasing your income:

1. Pay off your debt

Pay off as much of your current debt as possible before you apply for a mortgage. In most cases, lenders won’t include installment debts like car or student loan payments as part of your DTI if you have just a few months left to pay them off.

Start by paying down your debts with the highest interest rates, like credit cards. If possible, pay more than the minimum amount each month. If you have multiple debts with high interest rates, consider consolidating them into a single loan with a lower rate.

2. Don’t take on new debt

Hold off on making major purchases that require financing, like buying a car or taking out a personal loan. Avoid using your credit card for everyday expenses unless you can pay off the full balance each month.

3. Increase your income

If you’ve been at your job for a while and are a high performer, consider asking for a raise or working more hours. If your schedule allows, consider taking on a part-time job or freelance work to bring in additional income. If you have a skill or hobby that others might pay for, like photography, graphic design, or tutoring, use your skills as an extra source of income.

Young woman unloading shopping bags from her car in the Edgemont community in Edmonton AB

Edgemont Community, Edmonton, Alberta

How does my debt-to-income ratio affect my ability to get a loan?

Getting your finances in shape is an important part of preparing to buy a home, and you need to consider how your current debt may affect your ability to do so.

When you apply for a mortgage, lenders don’t just look at your current debts – they will also include your future monthly mortgage payment. By calculating your DTI ratio with the added responsibility of your new home loan, your lender will determine if you’re in a solid position to take on this significant financial commitment.

1. It shows lenders you can handle paying back lenders

Lenders like to see a proven history of your ability to pay back debts. Having a student loan that you paid off or showing you can manage multiple credit cards over the years makes you appear less risky as a borrower.

If you don’t have any history of managing debt – even a single credit card – lenders may not be as comfortable giving you such a large loan amount because you lack those indicators about your debt management abilities.

2. Managing debt well can improve your credit score

You want to show lenders that not only can you manage your debt, but you can do so in a positive way. Showing consistently solid debt management habits improves your credit score, which in turn can mean a lower interest rate, higher loan amounts, and more flexible terms.

Payment history is the largest factor in your credit score, so by consistently making your credit card, car loan, and other payments every month, you’re contributing to an overall improvement to your credit score. Likewise, missing payments or not paying the minimum amount would have a negative impact on your credit score.

The amount of money you owe is another major factor in determining your credit score. Credit utilization, or the percentage of your available credit that you’re currently using, should be below 30% on both individual lines of credit and as a collective total.

For example, if you have a $10,000 credit limit with an outstanding balance of $5,000, your credit utilization is 50%, which could drag down your credit score. The closer you get to reaching your credit limit, the riskier a lender will view you as a borrower, as they may think you’re spending beyond your means.

3. Having too much debt can make you ineligible for some home loans

A lower DTI ratio suggests you have a healthy balance between the money coming in and the money going out. A higher DTI ratio indicates that too much of your income is going towards paying down your debts, and this raises a red flag to a lender that you may be a risky borrower.

If your DTI ratio is too high, you may be ineligible for better home loan offers like lower down payment minimums or lower interest rates. You might also be required to pay private mortgage insurance (PMI) on your mortgage, which will add to your monthly expenses and further affect your DTI ratio and overall affordability.

Rockland Park Community by Brookfield Residential in Calgary AB

Rockland Park Community, Calgary, Alberta

Successfully managing your debt can help you get approved for mortgage, but the main thing is to make sure you're maintaining good habits to stay on top of it. Continue making on-time monthly payments, don’t let your credit utilization rate get too high, and be wary of the amount of debt you have compared to how much you earn. Stay informed, take action, and you’ll be on your way to a more secure financial future.

We understand the importance of finding the best place to call home and are committed to helping you every step of the way. Check out the Brookfield Residential blog for design advice, homebuying insights, mortgage tips, and more.

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