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Everything You Need to Know About Debt-to-Income Ratio Before Applying For a Mortgage

How and Why This Number Can Affect Your Mortgage Prospects

If you’re thinking of buying a home and will need to obtain a mortgage, be aware that two of the things lenders will ask about are how much debt you have and how much money you make. They use these numbers to calculate your debt-to-income ratio, which can affect whether you get approved a mortgage and how much you can borrow.

What Is a Debt-to-Income Ratio?

Your debt-to-income ratio is the total amount of debt your household is required to pay off each month (including such things as an existing mortgage, credit card bills, or loan repayments) divided by your total monthly gross income from all sources (before taxes and other deductions).

In the mortgage business, the Gross Debt Service ratio (GDS or GDSR) is used to determine this number.

Why It’s Important

The number resulting from that math equation is important, because lenders look at this to determine whether you can afford to take on a mortgage and how much money they should lend you. A high ratio means your household devotes a large portion of its income every month to paying off debts. Lenders want to make sure you can add the new mortgage payment to those debts without being left short of money for living expenses like groceries, clothing, and discretionary spending (which the DTI does not include).

GDS  Ratio Limitations

It’s a common misconception that lenders do not take into account the varying interest rates that can apply to different types of debt.

Lenders also don’t just look at your debt to income ratio to evaluate your finances. They also examine your credit history and rating, which demonstrates how well you have paid off debts in the past and how much of your available credit you are using. These are equally important indicators of whether you should be approved for a mortgage with best rates and terms and how much you can afford to borrow.

What Is a Good GDS Ratio?

Your GDS is your gross income compared to your monthly mortgage payment (at Qualification rate of 4.79%), property taxes, and heat (usually $100 is used). In most cases, the top end of acceptable qualification is 39%, however, best rate lenders will have individual policies fluctuating 32% to 44%.

How to Calculate Your GDS Ratio

Make a list of all your monthly debt payments, including:

  • Student loans
  • Car loans
  • Child support/alimony
  • Credit card payments
  • Any existing mortgage
  • Utility bills
  • Anything else you owe

Add up the amount of debt you’re responsible for each month and write it down. Draw a line under it.

How To Improve Your GDS Ratio Before Applying For a Mortgage

It may seem like a good idea to pay off some debts to lower your GDS ratio, but lenders also want you to have enough cash on hand. Plus, making a bigger down payment will lower the amount you need to borrow for your mortgage and will reduce your mortgage payments .  Speak with a mortgage broker to determine what is best – having more cash on hand or paying down debt – and develop a strategy for moving forward.

You should also check your credit score and see if you can improve it, since it’s the other aspect of your finances that a lender will examine closely.

The Takeaway

Your household’s GDS ratio is an important tool that can help you and your lender determine how much you can afford to spend on a home and whether they will give you the mortgage with the rate you are looking for. However, while a low ratio is definitely something to strive for, it may not be enough on its own—you need a strong credit score and solid savings in the bank as well. Plus, it’s important to know that every lender may adjudicate the file differently.

Talk to a mortgage broker about ways to improve your financial profile so you can get closer to your goal of purchasing a home.

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