How Your Income And Debt Determines How Much You Can Borrow

Posted on: 13 April 2017

When you go to a bank to apply for a mortgage loan, the bank will have two main goals. The first is to determine if you are creditworthy, and the second is to determine how much money you could afford to borrow. The bank will determine your creditworthiness by looking up your credit score, and they will find out how much you can afford to borrow by closely examining your income and debts.

They use a debt-to-income (DTI) ratio to do this

All lenders use DTI ratios when approving loans and deciding on maximum loan amounts. The purpose of the DTI ratio is to see if you could afford to pay a mortgage payment. A DTI compares the amount of your gross monthly income to the debts you must pay each month. Most lenders try to avoid making loans that would cause a person's DTI to exceed 43%; generally, lenders prefer keeping the ratio at or below 36%.

If you currently do not have any debt and earn a gross monthly income of $5,000, you would most likely qualify for a loan that has a payment of $1,800 (if the lender wants a 36% DTI).

There are two main DTI ratios used

Your bank will most likely calculate two different DTI ratios when analyzing your financial information. The first one is called a front-end ratio, which only compares expenses related to homeownership to income. The other ratio is called a back-end ratio, and this one also takes into consideration the monthly debt payments you have. This can include payments for car loans, student loans, and credit card bills.

The 36% ratio listed above refers to a back-end ratio, whereas a lender may stick with 28% for a front-end ratio. These ratios all vary by lenders, though, and you can find out more by contacting a mortgage lender. If you currently have a lot of debt, you may find that it is hard to qualify for a loan, especially for a relatively large loan. If you do not have debt, it will be a lot easier to qualify.

The bank you visit will ask you to fill out an application and turn in pay stubs. You will be required to list all debts on the application, along with their monthly payments, and the pay stubs are needed to prove your income. From this information, the bank will decide whether to give you a loan; and if they do, they will also decide how much they will loan you.