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When applying for a mortgage, we’ll perform an assessment of your financial situation to help determine what you can comfortably afford to spend on a home, taking into consideration whether you’re in a stable position to maintain your monthly mortgage payments. This is reassurance all lenders need before granting you a mortgage.
There are a number of considerations used to determine your financial position including an evaluation of your debt-to-income ratio (DTI). Having a solid DTI is a critical component for mortgage approval and will help ensure you receive the very best interest rate available today.
- DTI is a comparison of monthly debt payments versus monthly income. In other words, the amount you owe versus the amount you earn
- A lower DTI percentage demonstrates a certain comfort level with your current debt load and indicates to lenders that your overall financial situation is healthy
- If you fall within the ‘manageable’ DTI range, your lender may take a closer look at other considerations such as your age or location
What’s a debt-to-income ratio?
Expressed as a percentage, your debt-to-income ratio is a comparison of your monthly debt payments versus your monthly income. In other words, the amount you owe versus the amount you earn. Lenders use the ratio to determine how well you manage your monthly debt as well as your ability to repay a loan.
Monthly debt obligations include items such as credit card balances, existing mortgage payments, rent, condo fees, vehicle loans, insurance premiums and any personal loans. Examples of earnings include your income (and spouse’s income, if applicable), investment income, alimony or child support as well as government assistance programs.
Ideal debt-to-income ratio for mortgages
It goes without saying that the lower your DTI, the better. A lower percentage demonstrates a certain comfort level with your current debt load and indicates to lenders that your overall financial situation is healthy.
Typically, a DTI of 36% or below is considered good; 37-42% is considered manageable; and 43% or higher will cause red flags that may significantly impact your chances of qualifying for a mortgage. An ideal debt-to-income ratio, therefore, is any percentage that falls below 36% to err on the side of caution. These figures may vary slightly based on one lender to the next.
Important: Typically, a DTI of 36% or below is considered good; 37-42% is considered manageable; and 43% or higher will cause red flags that may significantly impact your chances of qualifying for a mortgage.
If you fall within the manageable range, your lender may take a closer look at other considerations such as your age or where you live. For example, if you’re a millennial just starting out, you’re likely not at your peak earnings, which may adversely affect your DTI just as it will for someone who’s on a fixed income. If you live in an expensive market, such as Toronto or Vancouver, a higher DTI would be taken into account as your cost of living is higher than in other areas.
Maximum debt-to-income ratio for mortgages
As noted above, a good DTI is 36% or less. If your calculations reveal that your DTI is over 50%, there is cause for concern. Not only will this negatively impact your ability to get a mortgage, but it also signifies that your payments are eating up a large portion of your income and you’re spending more money than you can afford. If you’re concerned that your current DTI will preclude you from obtaining a mortgage, you’ll want to take a closer look at your financial situation to see where you can make improvements that will have a positive impact on your DTI (see below for How do I lower my debt-to-income ratio?).
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Calculating debt-to-income ratio
The calculation for determining your DTI isn’t complicated, and it’s a good idea to know what it is before you get to the mortgage application stage. The first step is to add up your total monthly payments/debt and divide the number by your total monthly earnings/income. Turn the decimal point into a percentage by multiplying it by 100. This figure represents the amount of money you owe on every dollar you earn. If you aren’t comfortable doing the math yourself, there are a number of online calculators that can help.
Total monthly debt payments = $2,000
Total household income = $5,500 (before taxes)
$2,000 ÷ $5,500 x 100 = 36%
How do I lower my debt-to-income ratio?
Improving your debt-to-income ratio is possible, but it’ll take some time and discipline. Two of the most obvious options available are increasing your income or lowering your debt. You may not want to ask your boss for a raise or take on a second job to increase your income, so the more feasible solution is to reduce your debt. This won’t necessarily be easy, but the sacrifice you make now will pay off in the long run and could make all the difference in realizing your dream of homeownership. (See: 5 Tips to Improve the Mortgage Rates You Qualify For)
Tip: The most feasible solution for improving your DTI is to reduce your debt. The sacrifice you make now will pay off in the long run and could make all the difference in realizing your dream of homeownership.
By making changes to your existing habits and lifestyle, you can take back control of your financial future. Here are a few examples:
- Pay down your existing debt, especially high-interest credit cards and unsecured loans
- Establish a budget to identify areas where you may be able to cut back and save
- Avoid taking on any new debt
- Resist the temptation to purchase things you may want but don’t need
- Consolidate your debt into one loan with a single monthly payment
- Manage your expenses and be disciplined with what goes in and comes out of your bank account
DTI and credit score
Your DTI doesn’t directly impact your credit score, primarily because credit agencies don’t have any insight to your income level. There’s a correlation between the two, however, as the amount of debt you have impacts your ability to repay your mortgage. And, when considered together, they paint an accurate picture of your current financial position. The winning combination, therefore, is a low DTI and a high credit score, so make sure you have both. (See: Do You Understand Your Credit Score?)
Other articles in this guide: “How Much House Can I Afford?”
- Do You Understand Your Credit Score?
- How Much Do You Need for a Down Payment in Canada?
- CMHC 2019 Federal Budget: What It Means to First-Time Homebuyers?
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