Anybody who applies for a mortgage wants to get the lowest interest rate, but that depends on the credit score. This is the most important aspect that lenders take into consideration while lending money to borrowers. However, it is not just the credit score, but several other factors as well, which decide the interest rate on your mortgage. One such thing is the ‘debt-to-income’ ratio.
Lenders consider the big picture when qualifying you for a loan. They want to be sure about your financial status because there could be a chance that you have the best credit score, yet you are completely drowned in debts. Even if your credit score says that you aren’t a high risk, it is your debt-to-income ratio that tells the true picture.
Here is how your DTI affects your interest rate:
The housing ratio and your interest rate
The comparison between your gross monthly income and monthly housing payment results in your housing ratio. If the housing ratio is increased, then it becomes more difficult for you to pay the mortgage on time. If the loan amount you are considering puts your housing ratio close to the program’s limit, then the lender will offer you the mortgage at a higher rate.
The reason why lenders offer the mortgage at higher interest rates is to ensure their investment in case you are unable to pay the mortgage. The lender doesn’t doubt your ability, but this entire thing is done to ensure their money should you default. With a higher rate of interest, the lender gets his investment back a lot quicker.
Total DTI Ratio and your interest rate
If you want to know what your DTI includes, then here are the details:
- Installment loan payments.
- Your current housing payments.
- Credit card payments.
- Student loans.
The total DTI gives a clear picture to lenders as to how much of your income is already accounted for each month. In case, the number is too high, around 45%, then the loan may not be approved. If it is below 45%, then the loan may be approved, but the interest rate will be high because the lender believes he is taking a big risk by giving you a loan.
Can a low DTI Ratio help?
Yes, it certainly will, as the low debt-to-income ratio will have an opposite effect on your interest rate. If your DTI is low, then you will get the loan at a lower interest rate. Lenders always prefer borrowers that pose little to no risk of defaulting on their mortgage.
A low DTI doesn’t necessarily mean that your interest rate will be reduced. Lenders will factor in all the aspects when offering you a loan. For example, if your credit score is high, but the debt ratio is low, then you stand a good chance to get a lower rate. On the other hand, if the credit score and debt ratio are on the lower side, then you may not get the loan since your low credit score shows that you are a credit risk.