Before you shop for a house, add the mortgage payment you want to your other monthly debt payments and divide by your gross monthly income. Lenders judge your application by that debt-to-income ratio. It counts payments, not balances, so paying off a small debt entirely lowers it more than putting the same money toward a large one.
When a lender approves a mortgage, it’s approving a monthly payment, and the debts you already carry set the ceiling on it.
That ceiling comes from your debt-to-income ratio (DTI). Add your full new house payment, including property taxes, homeowners insurance, and any association dues, to every other monthly debt payment, then divide by your gross monthly income. Fannie Mae, whose rules govern the conventional loans it buys, allows up to 50% when its automated system approves the loan. A loan underwritten by hand tops out at 36%, or 45% with strong credit and cash reserves. Government-backed FHA and VA loans set their own limits.
Because the ratio counts payments, where you send extra cash matters. Extra payments on a car or student loan don’t shrink the required monthly payment, so the ratio stays put. Paying the loan off erases the payment. On $6,000 of gross monthly income, clearing a car loan with a $450 payment cuts your DTI by 7.5 points. Credit cards work differently, since the minimum payment falls with the balance.
Run the math before you pick a price range. If your debts already take 15% of gross income, a 36% cap leaves 21% for the house, or $1,260 a month on $6,000 of income. Then clear the debts with the biggest payments for their balance, and hold off on financing a car or furniture until after closing. Under Fannie Mae’s rules, an installment loan with 10 or fewer payments left may not count at all, so ask your lender before you pay one off early.
Every $100 of monthly debt payment you clear before applying is $100 more of house payment a lender can approve.
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