What is Too Much Debt for a Mortgage?

Getting a mortgage to finance buying a home is a major financial move for many people. However, having too much existing debt can make it difficult to get approved for a mortgage loan. Lenders want to ensure borrowers have the capacity to make their mortgage payments in addition to other financial obligations. As a result, your debt-to-income ratio is a key factor lenders evaluate when deciding whether to approve a mortgage.

What is the Debt-to-Income Ratio?

Your debt-to-income (DTI) ratio compares the amount of your monthly debt payments to your gross monthly income before taxes. It represents the percentage of your income that goes toward servicing debts like auto loans, student loans, credit cards, child support, and other recurring obligations.

To calculate your DTI, add up all your monthly debt payments, then divide that total by your gross monthly income. For example:

• Gross monthly income: $5,000
• Total monthly debt payments: $1,500
• $1,500 / $5,000 = 0.3
• DTI ratio = 30%

Housing-related costs like your mortgage, property taxes, and homeowners insurance are not typically included in the debt portion of the DTI calculation. However, there is a separate housing expense ratio that compares your gross income to housing expenses only.

Why DTI Matters for Mortgage Approval

Your DTI ratio gives lenders insight into how much of your income is already tied up in existing debts. The higher your DTI, the less disposable income you have available to put toward a new mortgage payment. As a result, a high DTI may make it challenging to qualify for a mortgage.

Here are typical DTI requirements from mortgage lenders:

• 36% or less – A DTI of 36% or lower is generally preferred and considered acceptable by most lenders. Borrowers with a DTI in this range are likely to get approved.

• Up to 43% – Some lenders may approve DTIs between 36% and 43%, especially for borrowers with otherwise strong finances like a high credit score or substantial assets.

• Over 43% – It becomes increasingly difficult to qualify for a mortgage when your DTI is over 43%. Approval is unlikely for DTIs above 50%.

So keeping your DTI as low as possible will boost your chances of mortgage approval and allow you to qualify for better interest rates. Aim for 36% or less if possible.

How Much Debt is Too Much for a Mortgage?

While every lender has their own standards as a general rule having a DTI above 43% starts putting your mortgage application at risk. According to mortgage data site HSH.com, borrowers with a DTI above 43% face a steep drop off in approval odds.

Some tips to avoid having too much debt for a mortgage:

• Pay down existing debts like credit cards and auto loans before applying for a mortgage Even small reductions can help drop your DTI,

• Avoid taking on new long-term debts that add to your monthly obligations.

• Consider adding a co-borrower to your mortgage application to supplement your income.

• Make a larger down payment if possible to reduce the required mortgage amount and payment.

• Work on improving your credit score to offset concerns over a higher DTI.

Ultimately, limiting your recurring debts, boosting your income, and managing your DTI ratio are key to maximizing your chances of mortgage approval.

How Lenders Calculate DTI for Mortgages

When evaluating a mortgage application, lenders will closely examine your finances to compute your debt-to-income ratio. Here are some key factors in how lenders calculate DTI:

Gross vs. Net Income – Your gross monthly income before taxes is typically used to determine DTI, rather than your after-tax net income. Gross income presents a more positive view of your earnings.

Debt Payments Included – All monthly payments for long-term debts are factored in, such as auto, student, personal loans, credit cards, child support, and alimony. Do not include utilities, food, entertainment.

Housing Costs – Mortgage, property taxes, homeowners insurance, and HOA fees are excluded from debt obligations in DTI specifically. But they are calculated separately in your housing expense ratio.

Minimum Payment vs. Actual Payment – For credit cards and other debts, lenders may use either your minimum required payment or actual typical monthly payment you make, whichever is higher. Paying down balances can help lower your DTI.

Special Circumstances – Certain debts like medical bills in repayment plans may be excluded by some lenders in determining DTI. Discuss your unique situation.

Tips for Managing Your DTI

Here are some suggested strategies for improving your debt-to-income ratio over time:

• Pay more than the minimums on credit card bills and other debts to pay them down faster

• Consolidate multiple higher-interest debts into a single lower monthly payment

• Limit new borrowing and avoid taking on additional financial obligations

• Build up your emergency savings fund so you are less likely to rely on credit cards during financial shocks

• Negotiate a higher salary or work extra hours/freelance to increase your gross monthly income

• Have a co-borrower contribute additional income to the mortgage application

• Improve your credit utilization ratio by limiting balances carried on credit cards

• Refinance existing debts like student loans to lower interest rates and monthly payments

• Boost your credit score through on-time payments and responsible credit card use

The Bottom Line

Having too high a debt-to-income ratio can jeopardize your mortgage eligibility and lead to loan denial. While some debt is normal, keeping your DTI under 36% is ideal, and certainly below 43%, for the best chances of mortgage approval. Limiting debts, increasing income, and managing credit use can help control your DTI over time. Discuss your specific situation with lenders to understand the DTI levels they prefer to see. With prudent money management, you can keep your debt manageable on the path to homeownership.