When it comes to getting a lender’s approval to buy or refinance a home, there are 3 numbers that matter the most: your credit score, debt-to-income ratio, and loan-to-value ratio. These numbers can affect your ability to qualify for a mortgage and how much it costs you. Here’s a rundown of what they are and why they matter.
Credit Score
Your credit score helps mortgage lenders evaluate your likelihood of paying back your loan. Many lenders have a minimum credit score for their loans. Plus, the higher your credit score, the better the interest rates your lender will offer you. For example, depending on the specifics of the loan, a 20-point increase in your credit score could reduce your rate enough to save you thousands of dollars over the life of the loan. A higher credit score can also help lower your rate for mortgage insurance, which is required for loans with less than 20% equity.
Debt-To-Income Ratio
Your debt-to-income ratio (DTI) helps lenders understand how much you can afford to pay for a mortgage each month given your existing monthly debt payments. Lenders add up what your monthly debt will be once you have your new home. This includes things like student loans, car loans, and credit card bills. Then they divide it by your gross monthly income.
Lenders set DTI limits for their borrowers to make sure that you can comfortably afford your mortgage currently and in the future. If your DTI is higher than the limit for your circumstances, you may not be able to qualify for that mortgage. In fact, a high DTI is the #1 reason mortgage applications get rejected. most lenders typically offer loans to creditworthy borrowers with DTIs as high as 43-47%.
Keep in mind that the lower your DTI, the easier it may be to qualify for a mortgage. If you have some flexibility on when you plan on buying or refinancing, take time to lower your DTI can make the mortgage process go much smoother.
Loan-to-Value Ratio
Your loan-to-value ratio (LTV) is a way to measure how much equity you have in your home. One way to think of LTV is the percent you still need to put towards the principal in order to fully own your home. The higher your LTV, the more you’re borrowing from your lender.
If you are buying a home and want to calculate your LTV, it’s easy to do yourself. First, subtract your down payment amount from the value of the house. Then, divide that number by the payment amount from the value of the house. For example, if the property is valued at $200,000 and your down payment is $20,000, your LTV would be 90%.
If you are refinancing your home and want to calculate your LTV, divide the remaining balance on your mortgage by the value of your home. For example, if your home is valued at $200,000 and your loan balance is $150,000, your LTV would be 75%.
For a home purchase, lenders often have a maximum LTV. Your exact LTV maximum depends on things like your property type, your loan amount, whether or not you’re a first-time homebuyer, how you’ll be using the property, etc.
If your LTV is greater than your lender’s limit for your circumstances, you’ll either have to increase your down payment or find a property at a lower price. If you buy a house with an LTV about 80% (meaning your down payment was less than 20%), your lender may require mortgage insurance.
For a home refinance, your LTV is important if you’re looking to do a cash-out refinance or get rid of mortgage insurance. Homeowners often do cash-out refinances for home renovations or debt consolidation. If you’re thinking about a cash-out refinance, most lenders require that your LTV stays at or below 80% post-refinance.
If you’re looking to get rid of mortgage insurance down the road, your LTV is the deciding factor. Remember that the more payments you make towards your mortgage, the lower your LTV will be. When you pay off enough of your loan your LTV reaches 78%, mortgage insurance for conventional, non-government loans cancels automatically. Mortgage insurance can also be canceled slightly earlier, at 80% LTV, upon your request, given that you’ve met your lender’s criteria. Remember that mortgage insurance for government loans like FHA can’t be canceled and is paid the life of the loan.
