Before house hunting, divide your monthly debt payments, including the mortgage you want, by your gross monthly income. Lenders judge you by that debt-to-income ratio. It counts payments, not balances, so paying off a small loan with over 10 payments left lowers it more than putting that money toward a big 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 the loan goes through its automated underwriting system. 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 loan or a student loan in repayment 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 12 payments of $450 left cuts your DTI by 7.5 points. Under Fannie Mae’s rules, a loan with 10 or fewer payments left may not count at all, so ask your lender before you pay one off early. Credit cards work differently, since the minimum payment falls with the balance.
Run the math before you pick a price range. Say 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 pay off whichever debts free up the most monthly payment for the cash it takes to clear them, and hold off on financing a car or furniture until after closing.
Every $100 of monthly debt payment you clear before applying, if your lender counts it, is $100 more of house payment it can approve.
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