When you apply for a mortgage, we assess your financial situation to determine the reasonable amount you can spend on the purchase of a property, taking into account that you are in a stable position to continue making your monthly mortgage payments. . It’s also a way to reassure lenders before they give you a mortgage.
Several factors go into assessing your financial situation, including an assessment of your debt-to-income ratio. Having a good debt-to-income ratio is essential to getting approved for a mortgage and will help you get the best available interest rate that day.
Key Takeaways
- The debt-to-income ratio is a comparison of monthly debt payments to monthly income. In other words, it is the ratio between the amount you have to pay and the amount you earn.
- A low debt-to-income ratio reflects a reasonable level of debt and tells lenders that your overall financial situation is healthy.
- If your debt-to-income ratio is “manageable,” your lender might take a closer look at other factors like your age or where you live.
What is a debt-to-income ratio?
Expressed as a percentage, your debt-to-income ratio is a comparison of your monthly payments and your monthly income. In other words, it is the ratio between the amount you have to pay and the amount you earn. Lenders use this ratio to gauge how well you are managing your monthly debt as well as your ability to repay a loan.
Monthly debt includes credit card balances, existing mortgage payments, rent, condo fees, auto loans, insurance premiums, and any personal loans. As for income—and spousal income, if applicable—it includes your investment income, alimony or child support, and benefits from government assistance programs.
Ideal debt-to-income ratio for getting a mortgage
It is best to have the lowest possible debt-to-income ratio. A low debt-to-income ratio reflects a reasonable level of debt and tells lenders that your overall financial situation is healthy.
Generally, a debt-to-income ratio of 36% or less is considered good. A ratio of 37% to 42% is considered manageable, and a ratio of 43% or higher is considered problematic and can have a significant impact on your mortgage eligibility. It’s safe to say that an ideal debt-to-income ratio is therefore less than 36%, but the percentages can vary slightly from one lender to another.
Generally, a debt-to-income ratio of 36% or less is considered good. A ratio of 37% to 42% is considered manageable, and a ratio of 43% or higher is considered problematic and can have a significant impact on your mortgage eligibility.
If your ratio is “manageable,” your lender may take a closer look at other factors like your age or where you live. For example, if you’re one of the millennials starting in life, you’re likely not generating the maximum income, which can adversely affect your debt-to-income ratio, just as it will for someone else. one who has a fixed income. If you live in a city with a high market price — like Toronto or Vancouver — a higher debt-to-income ratio might still be acceptable since the cost of living is higher than in other areas.
Maximum debt-to-income ratio to get a mortgage
As noted above, a good debt-to-income ratio is below 36%. If your calculations show that your debt-to-income ratio is above 50%, there is cause for concern. Not only will this negatively impact your ability to get a mortgage, but it also means that your payments are eating up a lot of your income and you are living beyond your means. If you’re concerned that your current debt-to-income ratio is preventing you from getting a mortgage, you need to take a closer look at your financial situation to identify improvements you can make to lower your debt-to-income ratio.
Calculation of the debt-to-income ratio
The calculation to determine your debt-to-income ratio is simple, and it’s a good idea to know your ratio before applying for a mortgage. The first step is to add up all of your monthly payments and divide the sum by all of your monthly income. Multiply the result by one hundred to get a percentage. The resulting percentage represents the amount you owe on every dollar you earn. If you don’t want to do the calculations yourself, there are several calculator tools to help you out.
How can I lower my debt-to-income ratio?
You can improve your debt to income ratio, but it takes time and discipline. Two of the most obvious options are to increase your income or reduce your debt. You may not want to ask your boss for a raise or take a second job to increase your income, so the most realistic solution is to reduce your debt, which is not necessarily easy, but the sacrifices you make now will pay off in the long run and could make all the difference in achieving your dream of home ownership.
The most realistic solution to improving your debt-to-income ratio is to reduce your debt. The sacrifices you make now will pay off in the long run and could make all the difference in achieving your dream of home ownership.
By changing your current habits and lifestyle, you can regain control of your financial future. Here are some examples :
- Pay off your current debts, especially high interest credit cards and unsecured loans.
- Set a budget to identify areas where you can cut expenses and save money.
- Avoid incurring new debts.
- Resist the temptation to buy things you don’t need.
- Consolidate your debts into one loan with one monthly payment.
- Manage your expenses and be disciplined about the inflows and outflows of money from your bank account.
Debt-to-income ratio and credit score
Your debt-to-income ratio has no direct bearing on your credit rating, mainly because credit agencies have no idea what your income level is. However, there is a correlation between the two, as the amount of debt affects your ability to pay off your mortgage. When considered together, they paint an accurate picture of your current financial situation. So the winning combination is a low debt-to-income ratio and a high credit score, so make sure you have both.