Your debt plays a vital role in determining whether you qualify for a mortgage or not. Lenders use an aspect of your debt, known as your debt-to-income (DTI) ratio, to assess your ability to repay, as well as how much you can borrow. Generally, most lenders prefer maintaining a DTI of 36 percent or less.
DTI serves as a financial measure that compares the amount of debt you have to your income. Mortgage lenders and companies, including issuers of mortgages, often believe that borrowers with small debt-to-income ratios are more likely to manage monthly payments.
Before you take on any debt, determine whether the debt will help you meet your financial goals or hinder you from doing so. For example, the type of debt you apply for can make a difference between an approved or denied mortgage.
To make an informed decision, determine the type of debt you wish to secure.
What are the Different Types of Debt?
- Secured debt. Any debt that uses a form of collateral is considered While lenders run credit checks before they offer a loan, they do require assets to be used as collateral. For example, if you are buying a car using credit, the lenders will offer them money, but they will place a claim of ownership in the vehicle. If you do not pay or repay on time, they will repossess the car and sell it to gain their money back.
Secured loans have reasonable interest rates. The rates, however, can vary depending on the value of the asset used as collateral.
- Unsecured debt. Unlike their secured counterparts, unsecured debts do not require collateral. Lenders will offer the loan according to your financial ability and promise to repay. But you have to sign an agreement so that they can hold you accountable in case you default.
Unsecured debts often have the highest interest rates. Typical examples are medical bills, signature loans, and credit cards.
- These loans are often taken by consumers who wish to buy a home. The residential property serves as collateral. Most homeowners have loans because they guarantee low-interest rates and can be paid for up to 30 years.
- Revolving debt. Consumers pay commitment fees to borrow money when needed. That enables the customer to borrow up to a certain amount regularly. This debt option is suitable for people with unexpected cash flow fluctuations or expenses. Though these debts offer flexibility and convenience, they attract higher interest rates compared to conventional installment loans.
The Bottom Line
Your debt-to-income ratio impacts the outcome of your mortgage. Customers with the lowest DTI often gain access to the best mortgages, as well as can easily repay their loans.
To lower your debt-to-income ratio before you apply for a mortgage:
- Avoid incurring more debt.
- Refrain from making big purchases on credit.
- Repay as much of your current debt as you can.
If you wish to learn more about your debt-to-income ratio or how you can apply it to your mortgage application, reach out to a loan expert for assistance.