Understanding Your Debt-to-Income Ratio for Home Equity Loans

When you apply for a home equity loan, most people know FICO and credit score will play into their ability to qualify for a loan. But are you aware of the effect your debt-to-income (DTI) ratio can have?

What is your DTI (debt-to-income) ratio?

According to Consumer Finance, Your DTI ratio is your monthly debt payments divided by your gross monthly income—the percentage of your gross monthly incomes (before taxes) that goes towards payments for rent, mortgage, credit cards, or other debt.

What is a good DTI ratio?

Debt-to-income ratio (DTI) is one of the most crucial factors that mortgage and home equity lenders take into account when figuring out whether a potential borrower is eligible for a home loan.

The guidelines on DTI vary from lender to lender, but Investopedia suggests it's best to stay around 36% to 43% or less. A low DTI ratio indicates sufficient income relative to debt servicing.

The bottom line is that the lower the DTI, the less risky a borrower appears to lenders.

What expenses do NOT get factored into DTI?

The following payments are not included in DTI calculation: Monthly utilities, car insurance expenses, cable and cell phone bills, health insurance costs and groceries. Talk to a lender for a proper assessment and to understand which of your payments should be included.

Does DTI impact your credit score impact

Your DTI not only affects your ability to obtain a loan, but it also indirectly impacts your credit. According to Forbes, a high DTI could lower your credit score and make it more difficult for you to rent, buy a home, lease a car or open a utility account.

How to lower your DTI ratio

1. Create a budget to track your spending: Reduce your unnecessary spending to provide more funds to debt repayment. Bankrate suggests to include all of your expenses, large or small, to enable you to set aside more funds for debt repayment.
2. Pay down existing debt:There are two strategies borrowers often use to pay down their debt, according to Lendingtree. The "debt avalanche" strategy calls for paying off your highest-interest debt first while maintaining minimum payments on all other debts which will eventually reduce your interest rates over time. On the other hand, the "debt snowball" approach prioritizes paying off the debt with the lowest balance first while continuing to make the minimum payments on their remaining obligations.
3. Increase your income: Another way to lower your DTI is to increase your income. In addition to having a higher gross income for the calculation, you'll also have the chance to pay off more debt, which can lower your DTI even further. TIME suggests switching jobs, negotiating a raise at your current job, working overtime hours, or picking up a second job or side hustle.
4. Avoid taking on more debt: Try to delay applying for new loans and think about lowering the amount you charge on your credit cards. This is especially important when buying a home, because taking on new debt and loans could lower your credit score in addition to increasing your DTI ratio.

If you're looking to tap your home's equity to consolidate high-rate debt, cover home improvement costs or anything else, DTI will come into play once you start your application.

But before you begin speaking to lenders, it's not a bad idea to determine an estimate of how much cash you may be able to access from your home. To do this, get in touch with us. It only takes a moment to get an estimate of your available equity.

And if you have questions about how to access cash from your home's available equity, we can help you find the solution that works best for you.