Buying a home is a multidimensional process, so it’s important you understand all of the facts before making the leap. Making sure your financial house is in order is critical as you navigate the lending process, and debt-to-income (DTI) ratio no doubt will enter into the equation.
When evaluating your fitness for a mortgage, lenders look at your financial health and certain markers like DTI can be telling about your responsibility as a consumer. Specifically, a DTI ratio provides a window into your past, as it compares the total amount you owe every month to the total amount you bring in each month. Lenders may consider this variable in the context of the larger picture when making a determination. For instance, they might review credit reports and credit scores in addition.
That said, you might be wondering how to work towards a lower DTI ratio. There are actions you can take to improve your DTI ratio, such as:
- Reducing your total debt by paying off credit cards and loans
- Avoid taking on new debt
- Consolidating debt to tackle it more aggressively
- Getting a better-paying job or a second one to position yourself more favorably
- Re-evaluating your budget to determine if there are any expenses you can trim
It also helps to understand how your credit report and score are used by lenders to make a decision. You should know that since income does not appear on your credit report and does not influence your credit score, your DTI ratio doesn't directly affect these. However, keep in mind that your outstanding debt is related to multiple factors that do affect your credit score, including your credit utilization ratio. This figure juxtaposes your total revolving debt (such as credit cards) with the total amount of credit you have available. Credit utilization ratios enter the equation in credit scoring. In addition, debt can affect your credit score based on:
- The total amount of debt you have
- The age of loans or revolving debts
- The mix of types of credit in use
- How many recent hard inquiries reflected on your credit report
- How consistently you've paid your debts over time
Now that you understand the basics, you can set yourself up for success when applying for a home loan. In this context, lenders will look at your DTI ratio, credit history, and score. Such variables can help them make a more informed decision about your ability to pay back the loan.
Also, if you’re concerned about a low or middle-of-the-road credit score, know that it takes time to right the ship. If you have this goal in mind, experts advise doing the following:
- Pay down existing debt
- Pay all bills on time every month
- Avoid applying for any new credit
Use your existing credit wisely
Remember, the pursuit of financial wellness is a worthy one but it’s not always easy. Set realistic goals and you can make the leap when the time is right for you.