Upstream and downstream debt / income ratios
Many mortgage lenders consider two different debt-to-income ratios when deciding whether to give you a mortgage and how much to lend. The two ratios include:
- The Initial Ratio: The Initial Ratio is the amount of your monthly income that will go towards housing costs after you buy your home. It takes into account your property taxes; your insurance; your mortgage payment of the principal and interest on your mortgage; and all owner association fees. You will divide the total value of housing costs by your income to get the original debt-to-income ratio for mortgage approval.
- The back-end ratio: The back-end ratio takes into account your housing costs as well as all your other debts. To calculate this, add up all of your financial obligations, including your housing costs, loan payments, car payments, credit card debt, and other outstanding loans.
Lenders generally consider both types of debt-to-income ratios; however, the back-end ratio is usually more important because it gives lenders the big picture of your finances.
If your housing costs will be a little high relative to your income but you have no other debt repayment obligations, a lender may be more willing to lend you. This is because your total financial obligations will still be manageable even with that larger mortgage loan.
What Debt-to-Income Ratio Do Lenders Want?
Typically, lenders want an initial debt-to-income ratio of 28% and a final ratio of 36%. However, some conventional lenders will allow a back-end ratio of up to 43%. If you are able to get a loan through a government-backed program, such as an FHA loan, your final debt-to-income ratio could reach 50%.
The lower your debt ratio, the more likely you are to qualify for a loan at a favorable mortgage interest rate. This is especially if you have other positive factors, such as a good credit rating.
How To Improve Your Debt Ratio For Mortgages
Unfortunately, many people have too much debt relative to their income to qualify for a mortgage. High monthly loan payments can result in a debt-to-income ratio that is too high to get a home loan.
To improve your debt-to-income ratio for mortgage approval, you could try earning more so that you have more income relative to your debt. You can and should also try to pay off the debt aggressively so that you have less debt that counts towards your monthly financial obligations.
Buying a home at a lower cost could also help, as it could lower your mortgage costs as well as property taxes and insurance costs.
A good debt-to-debt ratio is essential to qualify for a mortgage
It’s a good idea to know your debt ratio before you apply for a mortgage to make sure you can afford to borrow as much as you need.
If you don’t earn enough to qualify, you will need to lower your expectations about how much you can borrow. Alternatively, you can pay off your other debts before applying for a home loan. Calculating your debt-to-income ratio for mortgages is simple – just add up what you owe and compare it to your income and you’ll figure out this important number.