Monthly debts are regular, recurring expenses that you owe each month. These debts are often considered when applying for loans like mortgages, as lenders want to ensure you can afford the additional monthly payment. By understanding what counts as monthly debt and how to calculate it, you can better manage your finances and improve your chances of qualifying for loans with favorable terms.
What Counts as Monthly Debt?
Monthly debts typically include:
- Housing payments like rent, mortgage, property taxes, and homeowners insurance
- Minimum monthly credit card payments
- Auto loans
- Student loans
- Personal loans
- Alimony and child support
Essentially, any loan or credit account with a required monthly minimum payment would be considered a monthly debt. These show up on your credit report, which lenders review when you apply for a mortgage.
Other regular expenses like utilities, groceries, cable bills, cell phone plans, medical expenses, car insurance, etc. are NOT counted towards your monthly debts, even though you pay them each month. Since they don’t appear on your credit report, they aren’t factored into debt calculations.
How Monthly Debt Impacts Mortgage Applications
When you apply for a mortgage, lenders calculate your debt-to-income ratio (DTI) to determine if you can afford the monthly payment. DTI compares your total monthly debt payments to your gross monthly income.
There are two types of DTI ratios lenders consider
Front-end DTI
Measures just your housing-related costs like mortgage, property taxes, insurance, and HOA fees against your income.
Back-end DTI
Looks at your total monthly debts including housing costs and other debts like credit cards, auto loans, student loans, etc.
Most lenders want your back-end DTI to be 36% or less. In other words, they don’t want your total monthly debts to exceed 36% of your gross monthly income. The lower your DTI, the more likely you are to qualify for a mortgage with better terms.
Here’s an example of calculating DTI for a mortgage application:
- Gross monthly income: $5,000
- Estimated new mortgage payment: $1,500
- Minimum credit card payments: $200
- Auto loan payment: $300
Total monthly debts = $1,500 + $200 + $300 = $2,000
$2,000 / $5,000 gross monthly income = 40% DTI
In this scenario, the DTI is a bit high at 40% and could impact mortgage eligibility or terms By paying down debts or increasing income, you can lower your DTI and improve your chances of getting approved
Tips for Reducing Your Monthly Debts
Here are some strategies to decrease monthly debts and strengthen your financial profile:
- Pay more than the minimums on credit cards and loans to pay them off faster
- Consolidate multiple high-interest debts into a single lower interest loan
- Refinance existing debts like student loans or auto loans at lower interest rates
- Avoid taking on new monthly debts prior to applying for a mortgage
- Increase your income with a promotion, new job, or side gig
- Add a co-signer with better credit to strengthen your mortgage application
- Ask lenders to exclude short-term debts like student loans nearing repayment
Carefully managing your monthly debts and DTI ratio will help improve your chances of qualifying for the best mortgage terms. Shop around with multiple lenders to find the most favorable rates and loan options. Be prepared to explain any unique circumstances impacting your DTI. With smart planning, you can position yourself financially to become a homeowner.
Frequently Asked Questions About Monthly Debt
What monthly debts are included in DTI ratio calculations?
Monthly debts factored into your DTI generally include:
- Mortgage payments
- Minimum credit card payments
- Auto, student, and personal loans
- Alimony and child support
Monthly expenses NOT included are utilities, groceries, insurance, medical bills, etc.
How much monthly debt is too much when applying for a mortgage?
Most lenders want your back-end DTI to stay under 36%. Total monthly debts higher than 36% of your gross income will hurt your chances of qualifying for a competitive mortgage.
Can I qualify for a mortgage with high monthly debts?
You may still qualify if you have compensating factors like a large down payment, stellar credit, or significant assets. But high monthly debts will likely mean higher interest rates or smaller loan amounts. Improving your DTI can help you land better mortgage terms.
Should I focus on paying off debt or saving up for a home down payment?
It depends on your situation, but paying down monthly debts to decrease your DTI is usually advisable before taking on a mortgage. Work on reducing credit card and loan balances first, then boost savings for a down payment.
How long will monthly debts impact my credit and mortgage eligibility?
Most negative credit information stays on your report for 7 years. But the impact on your scores can lessen over time. Stay diligent about paying monthly debts on time going forward. Past mistakes become less important the longer you demonstrate responsible habits.
The Bottom Line
When applying for a mortgage, lenders closely scrutinize your recurring monthly debts and debt-to-income ratio. Keeping monthly debts low and managing your DTI can help strengthen your application and unlock better mortgage terms. Evaluate your unique situation to determine the best strategies for reducing your monthly obligations. With prudent planning, you can set yourself up for mortgage approval on your path to homeownership.
Your DTI ratioYour DTI ratio should help you understand your comfort level with your current debt situation and determine your ability to make payments on any new money you may borrow. Remember, your DTI is based on your income before taxes – not on the amount you actually take home.
Relative to your income before taxes, your debt is at a manageable level. You most likely have money left over for saving or spending after you’ve paid your bills. Lenders generally view a lower DTI as favorable.
You have an opportunity to improve your DTI ratio
It appears you are adequately managing your debt, but you may want to consider lowering your DTI. This could put you in a better position to handle unexpected expenses. If you’re looking to borrow, keep in mind that lenders may ask for additional eligibility factors.