What Percent Does a Lender Generally Look For When Considering a Loan Application?

When applying for a mortgage or other type of loan, one of the key factors a lender considers is your debt-to-income (DTI) ratio. This measures how much of your monthly income is already committed to existing debts. Lenders generally look for your DTI to be below a certain percentage to ensure you can afford the new loan payment.

What is a Debt-to-Income Ratio?

Your debt-to-income ratio compares your total monthly debt payments to your gross monthly income before taxes and other deductions It’s expressed as a percentage For example, if your total monthly debt payments are $2,000 and your gross monthly income is $5,000, your DTI is 40% ($2,000/$5,000).

There are two main types of DTI ratios lenders look at:

• Front-end DTI – Compares your monthly housing costs (mortgage/rent, property taxes, insurance, HOA fees) to your gross monthly income.

• Back-end DTI – Compares all your monthly debt payments (including housing) to your gross monthly income.

What DTI Percentage Do Lenders Want?

When considering a loan application, lenders generally look for the back-end DTI to be 36% or less. However, maximum allowed DTIs can vary by loan type

• Conventional loans – Typically allow DTIs up to 45%.

• FHA loans – Allow DTIs up to 55%.

• VA loans – No set maximum, determined case-by-case.

• USDA loans – No maximum, but prefer 41% or less.

Even though higher DTIs may be allowed, most lenders ideally want to see your back-end DTI at 36% or less. The lower your DTI, the less financial risk you represent.

Front-End DTI Guidelines

For your front-end DTI specifically looking at housing costs, lenders ideally want to see this ratio at 28% or less of your gross monthly income. However, up to 36% is generally still considered acceptable.

So for example, if your income is $6,000 per month, lenders would want your total housing costs to be $1,680 or less (28% of $6,000).

Why DTI Matters to Lenders

Lenders want to limit DTIs because the lower your existing monthly debts, the more likely you’ll be able to afford the new loan payment. A high DTI indicates you may already be overextended financially.

Specific reasons a lower DTI is better include:

• Lower default risk – You’re less likely to miss payments if debts consume a smaller portion of your income.

• Ability to absorb unexpected costs – Lower debts leave more room in your budget for unplanned expenses.

• Reduces impact of income fluctuations – If your income changes, lower debts reduce the impact on your ability to pay.

• Easier to qualify for financing – The lower your DTI, the more qualified lenders will view you.

Tips for Improving Your DTI

If your DTI is too high, here are some tips for lowering it to improve your chances of loan approval:

• Pay down existing debts to reduce your monthly payments. Target high-balance debts first.

• Avoid taking on new credit or loans before applying.

• Limit large expenditures that require new loans or financing.

• Increase your income with a second job, promotion, bonuses, etc.

• Reduce monthly expenses like utilities, childcare, cell phone plans, etc.

• Choose a less expensive home/car to minimize new loan payments.

• Make a larger down payment to decrease the monthly mortgage cost.

• Add a co-signer with better credit/income to strengthen the loan application.

The 36% DTI Rule of Thumb

As a general rule of thumb, try to keep your back-end DTI at or below 36% if possible. This is the sweet spot most lenders like to see for optimal loan approval odds.

Some exceptions may be made for DTIs up to 45% or even 50% for borrowers with excellent credit scores and sizable down payments. But keeping your DTI to 36% or less is your safest bet for smooth sailing during the lending process.

Monitoring your DTI over time and taking steps to lower it can have huge benefits for loan approvals and overall financial health. Aim to be in lender’s comfort zone with your DTI, and you’ll be better positioned to get approved for mortgages, auto loans, and other types of credit on favorable terms.