Even if you're a high earner, this factor can still result in your mortgage application being denied.

Even if you're a high earner, this factor can still result in your mortgage application being denied.
Even if you're a high earner, this factor can still result in your mortgage application being denied.
  • According to the 2024 Profile of Homebuyers and Sellers report by the National Association of Realtors, the most common reason for a denied mortgage application was a debt-to-income ratio of 40%.
  • Lenders and financial institutions assess your debt-to-income ratio to determine if you can afford to take on a mortgage payment along with your existing debt obligations.
  • Here's how to improve your DTI ratio, according to experts.

Ensure that your debt-to-income ratio is in check before applying for a mortgage to purchase a house.

The debt-to-income ratio is the primary metric lenders use to assess your ability to repay monthly loans, as stated by the Consumer Financial Protection Bureau.

According to the 2024 Profile of Homebuyers and Sellers report by the National Association of Realtors, the most common reason for a denied mortgage application was a debt-to-income ratio of 40%.

The report found that a low credit score (23%), unverifiable income (23%), and not enough money in reserves (12%) were other factors that affected homebuyers in the approval process.

A new high was reached by 26% of homebuyers who paid all-cash, as revealed by a NAR poll of 5,390 buyers who purchased a primary residence between July 2023 and June 2024.

Lenders look for a 'healthy' debt-to-income ratio

According to the NAR, the trend of record home equity among repeat buyers was driven by those who gained equity in recent years.

Lenders and institutions assess debt-to-income ratio to determine if borrowers can afford to add a mortgage payment to their existing debt obligations.

A higher debt-to-income ratio decreases the likelihood of lenders feeling comfortable loaning to you, according to Clifford Cornell, a certified financial planner and associate financial advisor at Bone Fide Wealth in New York City.

All home applicants, regardless of income level, are affected by a certain factor, according to Shweta Lawande, a certified financial planner and lead advisor at Francis Financial in New York City.

Even if you're a high earner and don't face challenges saving for a down payment, it doesn't necessarily mean your debt to income ratio is healthy, she pointed out.

Here's what you need to know about your debt-to-income ratio.

How to calculate your debt-to-income ratio

To apply for a mortgage, the initial step is to determine your current DTI ratio, advised Lawande.

To calculate your debt-to-income (DTI) ratio, divide your total monthly debt payments by your gross monthly income, then multiply the result by 100.

According to LendingTree, a DTI ratio of 35% or less is generally considered "good."

A sales manager at Bay Equity, a Redfin-owned mortgage lender, stated that sometimes lenders can be flexible and approve applicants with a debt-to-income ratio of 45% or higher, according to CNBC.

Pending home sales rise 2% monthly

The 28/36 rule is a way to determine your housing budget, which suggests that you should not exceed 28% of your gross monthly income on housing costs and no more than 36% of that total on all debts.

If someone earns a gross monthly income of $6,000 and has $500 in monthly debt payments, they could afford a $1,660 a month mortgage payment if they follow the 36% rule. If the lender accepts up to 50% DTI, the borrower may be able to take up a $2,500 monthly mortgage payment.

Most loan programs have a maximum approval limit, according to Nevins, who spoke to CNBC.

The 'better' debt repayment strategy

You can improve your debt-to-income ratio by either reducing your current debt or increasing your income.

Experts suggest two methods for paying off debt: the "snowball method" and the "avalanche method."

According to Shaun Williams, private wealth advisor and partner at Paragon Capital Management in Denver, the No. 38 firm on CNBC's 2024 Financial Advisor 100 List, the snowball method involves paying off the smallest debt balances first, regardless of the interest cost, which can make the process feel less overwhelming.

According to Williams, the best option for a spreadsheet is one, while the other is what makes someone feel best from a behavioral finance perspective.

He said that the avalanche is better because the true cost of debt is your interest rate, which means you're more likely to pay down the debt faster.

Cornell advised that if you have student loans with a 6% interest rate and a credit card balance accruing a 20% interest rate, it's better to tackle the credit card debt first.

"Paying down the loan that costs you the most money should be your top priority," he advised.

To avoid taking on more debt, focus on increasing income and avoiding large purchases that require financing, advised Lawande.

She stated that the objective is to maintain the cash flow to the greatest extent possible.

by Ana Teresa Solá

Investing