Debt-to-Income Ratio for Mortgage Qualification

by Brandon Cornett

A reader of my home buying blog recently asked the following question: "What kind of debt-to-income ratio do I need to qualify for a mortgage loan? What is the highest ratio an underwriter will consider?"

Before we answer these questions, let's cover some basic terminology for those who aren't well versed on the mortgage application process. There are two terms we need to define within this question:

Debt-to-income ratio (DTI): This number, expressed as a percentage, shows the relation between your long-term debt (including housing expenses) and your annual gross income. It is the percentage of your annual income that goes toward debt payments each year. It's also one of the things a mortgage lender will consider when deciding whether or not to approve you for a home loan.

Mortgage underwriter: This person analyzes your loan application and your financial background (DTI, credit score, etc.), and will then either approve or decline you for the loan. In other words, this is the person who weighs the amount of risk involved in loaning you money.

Your debt-to-income ratio is also referred to as a "qualifying ratio," because it's one of the things that will qualify you for a home loan. But it's not the only qualifier -- your credit score weighs heavily here as well.

Within this context a lower ratio is good, because it means less of your income is going toward debt each month. A higher DTI is bad. And this leads us to the reader's question that began this article. Is there some kind of debt-to-income cutoff point above which a mortgage underwriter will disapprove the applicant? And if so, what is it?

Historically (i.e., prior to the current financial crisis), mortgage lenders preferred borrowers to have a debt-to-income ratio of 30 - 35 percent or lower. Of course, it's a case-by-case basis in which different lenders have different criteria. But that percentage was a rule of thumb that applied most of the time.

You probably know what I'm about to say next, because I used the word "historically." You guessed it -- everything has changed in the wake of the subprime loan crisis that spread throughout our economy. In fact, financial history is being made as I write this article (in September 2008).

Today, lenders will require better numbers across the board before they'll give out loans. Home buyers in the current economy must have higher credit scores, longer credit histories, and better DTI ratios in order to (A) qualify for a loan and (B) get a decent interest rate on that loan.

With all of that being said, there is no "cut off" ratio that I can give you. All I can say with certainty is that:

Debt-to-income limits will vary from one lender to the next.
The rule of thumb from five years ago no longer applies today.
Mortgage lenders have much stricter criteria today.
Most financial institutions today are operating in "self-preservation mode."
Because of item #4, their underwriting criteria are in a current state of flux.
Getting pre-qualified for a long is the best way to find out where you stand.

This article is not meant to discourage you away from buying a home. It is merely intended to open your eyes to the current state of things. By understanding the economy in general, and the housing market in particular, you can make the right preparations before applying for a loan. You'll also have more realistic expectations when you know what's going on.

About the Author: Brandon Cornett publishes a number of educational websites for consumers. He is the creator of this real estate information website as well as the Home Buying Institute.