If you are looking to buy a house or apartment any time soon, you likely know that interest rates are on the rise. As you move through the process of checking in on your credit reports and tidying up loose ends to strengthen your credit score, there are other important factors to keep in mind with your finances. While many people think saving for – and having a large enough – down payment will make you more appealing to lenders, another factor also plays an equally important role.
Research performed by NerdWallet of the mortgage applications processed in 2020 under the Home Mortgage Disclosure Act showed that lenders processed 10% more mortgage applications than the year before — about 6.5 million compared with 5.9 million in 2019. And while the share of those applications that were approved – some 73% – and the share denied, at 8%, were the same for both years, the increase in applications resulted in about 58,000 more denials in 2020.
The biggest reason for a lender to reject a mortgage application? In 2019 and 2020, the Nerdwallet survey found that debt-to-income (DTI) ratio was the most common reason for a mortgage request to be denied, accounting for a whopping 32% of all rejections. A closer look found that 21% of applications of those with a DTI of 50% to 60% were denied, and 85% of those applicants with a DTI of more than 60% were denied.
What is DTI? It’s the percentage of your income that goes to pay your debts. When reviewing mortgage applications, lenders take into account how much debt a borrower already has and what the new debt of the mortgage will add to the load. Too much debt and you could have trouble meeting all of your monthly financial obligations.
Ideally, financial institutions and other lenders don’t want you to spend more than 28% of your total monthly income on mortgage debt, and not more than a total of 36% on all recurring monthly debts. That percentage includes your new mortgage. They want to make sure you also have enough money in your budget for retirement savings, food, gas and other savings goals such as funding college and vacations.
For example, if you (or you and a partner) bring home a combined monthly income of $5,000, you wouldn’t want to spend more than $1,400 on house-related expenses (a mortgage, plus insurance and property taxes) and $1,800 on total debt, which equals the 36% threshold lenders want you to maintain.
To make sure you are in that ballpark, list out all of the debts you now pay monthly including credit card bills, student loans, car loans, child support and alimony. There are other monthly expenses, according to real estate company Redfin.com, that lenders typically won’t ask you about. Those include electricity and other utilities, gas, groceries, child care, telephone bills and insurance expenses.
If you get through the list and realize your debt-to-income ratio for housing expenses and debt is going to be well over 36% each month, there are some things you can do to whittle away at the difference. For starters, begin paying more on your credit card accounts, the ones with the highest interest rates first.
With reporting by Casandra Andrews