A lender may reject a borrower for a home loan based upon his levels of monthly debt. Lenders use monthly debt levels compared to income, known as a debt-to-income (DTI) ratio, in order to determine whether a borrower can afford a monthly mortgage payment. Individuals should tabulate their monthly payments in order to work out a budget to pay down their debt, so they can lower their debt-to-income ratios and save money on interest charges.
Monthly debts include long-term debt, such as minimum credit card payments, medical bills, personal loans, student loan payments and car loan payments. Credit card balances do not count as part of a consumer's monthly debt if she pays off the balance every month. Lenders also consider spousal support (alimony) and child support as long-term debt obligations when they calculate eligibility for a home loan. Lower monthly debt levels will improve an individual's credit score, allowing her to obtain lower interest rates on lines of credit.
Lenders consider the borrower's front end ratio and back end ratio when looking at monthly debt levels. A front end DTI ratio refers to the borrower's anticipated mortgage payments, property taxes and homeowners' association fees as a percentage of his gross income. A back end ratio refers to the borrower's home expenses plus the monthly minimum payments he makes on other forms of debt.
If a borrower wants to purchase a home with a $500 monthly mortgage payment and makes $2,000 a month in gross income, she has a front end monthly debt ratio of 25 percent. If that same borrower owes $500 in minimum payments on a car loan and credit cards, she would have a back end monthly debt ratio of 50 percent. Many lenders prefer borrowers to have no higher than a 28 percent front end monthly DTI ratio and a 36 percent back end DTI ratio, according to Bank of America.
Individuals can lower their monthly debt levels by creating and implementing a budget. With a budget, consumers will track their monthly expenses and come up with a plan to reduce their levels of spending. They can then apply extra money saved every month to personal loan and credit card balances. As they pay these loans off, creditors will lower monthly minimum payments which will improve a borrower's debt-to-income ratio. A consumer who pays extra on fixed loan payments, such as an existing mortgage or a car loan, will not lower his level of monthly debt.