What is considered ‘debt’ when applying for a mortgage?

When you apply for a mortgage, lenders review your finances to decide whether you qualify for a loan, how much house you can afford, and what your interest rate will be. One key factor that lenders consider is your credit report, which provides a detailed summary of your debts and repayment record for credit cards, student loans, auto loans, and other financial obligations. This helps lenders understand how much debt you have and how responsible you are with your money. But what is considered monthly debt when applying for a mortgage? exactly counts as debt? Read on to learn more about what mortgage lenders consider debt when reviewing your finances.

Understanding the debt-to-income ratio in mortgage applications

One of the key metrics lenders use is your debt-to-income ratio, which compares your income to your debt payments. Most lenders want your DTI ratio to be 43% or lower. That shows that you are handling debt responsibly. Many lenders, however, like to see a DTI ratio of 36% or lower. Some lenders allow a higher DTI ratio, but a lower ratio generally improves your chances of approval and of getting the best terms on your loan.

Types of debt included in the DTI ratio calculation

If you’re like a lot of people, you have almost no money left over at the end of the month. But don’t worry, that doesn’t mean your DTI is 98%. What are monthly debts, and which ones count when calculating your DTI ratio? Only certain monthly financial obligations count. Here are the most common ones.

Rent or mortgage payments

Whether you’re renting or paying a mortgage, that payment is included in your DTI ratio. If you are applying for a mortgage and you will not be paying rent when you get it, lenders will use your future mortgage payment. If you are applying for a second mortgage, they’ll include both mortgage payments. Lenders also distinguish between your front-end DTI, sometimes called your housing ratio, and your back-end DTI.

• Front-end DTI: This includes only housing-related expenses, like your rent, mortgage or expected mortgage, property taxes, homeowners insurance, and homeowner association fees.
• Back-end DTI: This includes your front-end DTI expenses plus all other applicable debts.

If you’re buying your first home, lenders use your rent to assess how well you’re handling your existing housing expenses.

Loan payments

If it’s a recurring loan payment, it’ll be counted in your back-end DTI ratio. Lenders will count the minimum monthly payment in their calculation. Here’s a list of common types of loans included:

• Auto loans
• Personal loans
• Home equity loans
• Student loans
• Retail or department store loans

Note that personal loans differ from home equity loans and student loans, but they all count in your debt column of your DTI ratio. Lenders use these to determine how much new debt you can take on.

Student loans

Student loans are a unique type of loan, and lenders know this. They do count in your DTI calculations, but there are some specific facts you should know. Most of the time, the minimum required monthly payment is the amount lenders will use in their calculation, not the amount you pay.

However, in some cases, such as Fannie Mae loans or FHA loans, the calculations can get more complicated. For instance, if your payment is $0 because of deferment or other reasons, Fannie Mae uses a figure of 1% of your total loan amount for DTI calculations. FHA uses 0.5%.

Credit card payments

While credit card payments count in DTI ratio calculations, the good news is that lenders use your minimum monthly payment. So, if you regularly pay more than the minimum, don’t worry.

Child support payments

If you are divorced, child support or alimony payments count toward your DTI ratio.

If you pay child support, it will be counted as debt. Alimony, on the other hand, is subtracted from your gross income – an important nuance.

If you are receiving child support or alimony, the rules get a bit trickier. These payments will be included in your income – reducing your DTI ratio – but only if you can prove that they have been paid for at least six months and will continue for at least three years after your mortgage closes. You will need to show documentation for this.

Debts typically excluded from the DTI ratio

Life comes with a lot of expenses, but not all of them are considered in your DTI ratio. There are many everyday bills, and even some that seem recurring, that don’t count in your DTI. Here are the common ones.

Utilities and phone bills

While your cell phone, internet, and cable bills might be one of your most hefty monthly obligations, they are not considered in your DTI ratio. Neither are your utility bills, such as gas, electric, water, or trash. So even if these are several hundred dollars a month, they don’t count. However, you should consider them in your budget when deciding how much house you can afford.

Personal expenses

Personal expenses are not included in your DTI ratio. These include everything from groceries and dining out to haircuts and gym memberships. Additionally, contributions to savings or retirement accounts and moving costs are not counted.

Insurance premiums

While car insurance, health insurance, and out-of-pocket medical expenses may feel like mandatory monthly obligations, lenders do not factor these into your DTI ratio. There is one important exception: homeowners insurance. Because it directly relates to your housing expenses, it counts toward your front-end DTI ratio.

Alimony payments

Again, alimony payments are deducted from your gross income and are not considered as debt in your DTI ratio. Because of this, alimony can help keep your back-end DTI ratio lower.

How to calculate your DTI ratio

Because your DTI ratio is so important to mortgage lenders, knowing how to calculate your own DTI is vital. There are good home affordability calculators that you can use. But if you want to determine your DTI the old-fashioned way, it’s a simple formula:

DTI = (Total Monthly Debt Payments / Gross Monthly Income) x 100

• Total Monthly Debt Payments: Include all recurring debts, such as auto loans, personal loans, your expected mortgage payment, including taxes and insurance, credit card and student loan minimum payments, and child support.
• Gross Monthly Income: This includes your salary, rental income, Social Security benefits, or other pre-tax income.

So, let’s say you earn $6,000 per month gross income and have $2,400 in monthly debts.

Your DTI = ($2,400 / $6,000) x 100 = 40%

That would be considered an acceptable DTI for many lenders. But if you wanted to lower your DTI, you could either pay down your debts or earn more money.

How can your debt affect getting a mortgage?

By now, you can see how important your DTI ratio is to getting a mortgage. A lower DTI ratio can help you qualify for a broader choice of mortgages with more favorable terms, including a lower interest rate. This can save you thousands of dollars over the life of your loan.

Of course, while your DTI ratio is important, it’s still only part of the picture. Other data points, such as your total debt-service, credit score, and down payment amount, also are important when determining how much you should spend on a house.

It also pays to learn about the different types of mortgages. Assuming you have an acceptable DTI ratio, here’s a rundown of some popular loan types, with their credit score and down payment requirements:

• Conventional loans: Minimum credit score of 620, but if you have a strong credit score (usually 740 or higher), you may only need a 3% down payment.
• FHA loans: These are designed for those with lower credit scores, so if your score is 580 or higher, you may qualify with as little as 3.5% down.
• VA loans: These loans require no down payment for eligible veterans, active-duty military personnel, and their surviving spouses. They don’t have a minimum credit score, but most lenders require 620 or higher.
• USDA loans: These loans also require no down payment and are designed to help low-to mid-level borrowers buy homes in specific rural areas. Rocket Mortgage® does not offer USDA loans.
• Jumbo loans: These are for home loans that exceed the conforming loan limit, which is $806,500 in most parts of the country and $1,209,750 in specific high-cost areas. You’ll need excellent credit and a lower DTI ratio to qualify.

FAQ

How much debt can I have and still get a mortgage?

This varies by lender and type of loan. Each lender has their own view on what is a good DTI. However, most lenders want your monthly debts to be 43% or less of your gross monthly income, which is your income before taxes. Your debts include your future mortgage payment.

What is not included in my DTI ratio?

Your DTI does not factor in monthly bills such as medical debts, utilities, cell phone, cable, internet, car, or health insurance.

What debt is included in my DTI ratio?

Any revolving, recurring monthly debts are included in your DTI. These include minimum credit card and student loan payments, car and personal loan payments, line of credit payments, child support, and mortgage payments.

How can I lower my overall DTI ratio?

Lowering your DTI ratio can help you qualify for better loan terms. To lower your DTI ratio, you can pay off debts or earn more money. It also might be a good idea to review your budget or seek help from a financial advisor.

The bottom line: Calculate your total monthly debt to determine your DTI ratio

Your DTI ratio is an important factor in your ability to get a mortgage. If it is too high, paying off debts or increasing your income will reduce it. This could increase your chances of qualifying for a mortgage, get better loan terms, and a lower interest rate that can save you thousands over the life of your loan.

When you’re ready to buy a home, Rocket Mortgage can help you explore all your options. Start your mortgage approval process online or give us a call at (833) 326-6018.