How does Debt to income ratio affect affordability in the Uk?
In this blog, we will discuss debt to income ratios and how they could affect the mortgage you get. Many prospective borrowers often wonder how much debt they can have to qualify for a mortgage and if they should look to get a better debt to income ratio before they get a mortgage. In this blog, we will answer those questions.
What is your debt to income ratio?
Your debt to income ratio is the total amount of debt you have in relation to your income. This can be your monthly debt to income ratio or your annual debt to income ratio. More commonly the debt to income ratio is used to represent your monthly income in relation to your monthly debt.
Most lenders will be able to see your debt to income ratio by looking at the data on your credit file. This is because your credit file will contain all your debt accounts which you currently service and the amounts you pay per month. The lender can then use these figures in line with the income information you have provided to determine what your debt to income ratio is and if they are willing to lend to you based on that debt to income ratio.
Mortgage lenders will also consider your credit score when considering if to lend to you. If your credit score is low then you should consider building credit before applying for a mortgage.
How to calculate your debt to income ratio?
To calculate your debt to income ratio you should add up all your monthly debt repayments for every credit account (example your credit card account, your mortgage repayment, your personal loan repayments, your homeowner’s loan etc) you have and divide this by your gross monthly income. Your gross monthly income is the amount you make before any tax is charged.
Example of debt to income calculation:
If your monthly debt is £2,000 and your gross monthly income is £5,000 then you will have to divide £2,000 by £4,000. This will give you a debt to income of 50% or 0.5.
Does your debt to income affect your credit score?
No, your debt to income currently doesn’t affect your credit score as the credit bureaus currently do not collect your income data as part of the credit file data they hold on you. Although your credit file data doesn’t collect your income most mortgage lenders will ask you for your income data in order to calculate your Debt to income. Your debt to income is very important as it affects your mortgager affordability. Mortgage lenders will not lend to you if they feel your debt to income ratio is too high. A high debt to income ratio means your debts are almost as much as your income and you may not be able to afford a mortgage. A low debt to income ratio means your debts are much lower than your income and that you may be able to afford a mortgage.
Whilst your debt to income does not affect your credit score, there are other factors relating to your debt which may affect your credit score. E.g your credit utilization.
Some other factors which may affect your credit score which has to do with your debt include:
The total amount of debt you have
How many recent hard inquiries have been made into your credit report
Your repayment history on your debts
How consistently you’ve paid your debts over time
The age of loans or revolving debts
The mix of types of credit you’re using
What is a good debt to income ratio?
Generally, most mortgage lenders will want your debt to income ratio to be as low as 30% but you may be able to find mortgage lenders who are willing to lend to you with a debt to income ratio of 40% and above.
Types of debt to income
There are two types of debt to income ratios.
The front end debt to income ratio
The back end debt to income ratio
Front-end debt to income ratio will look at how much of your monthly debts go towards your housing costs such as your mortgage, your insurance and any home taxes.
The back-end debt to income ratio will look at all your monthly debt payments including your housing costs.
When considering you for a remortgage the mortgage lender will look at your front end debt to income ratio so as to not consider some of the costs that the new mortgage will essentially replace.
How to improve your debt to income ratio before a mortgage?
If you want to improve your debt to income ratio to increase your mortgage affordability then you here are a few things you can do.
Refinance your current debt to reduce your monthly mortgage repayments
Close debt accounts which you don’t need
Pay off some of your current debts in a few or one lump sum. e.g your credit card debts
Do not take on any new debt
Improve your income by taking on extra working hours, getting a new job etc
Wondering how to find funds to reduce your current debt then consider cutting down on some of the costs which you may not need. E.g the gym, spending money on dining outside etc
Reducing your debt to income ratio could also potentially increase your credit score.
How do mortgage lenders use your debt to income ratio?
Most mortgage lenders will look at your debt to income ratio but these aren’t the only factors that they will consider. The mortgage lender will also consider your mortgage deposit, your credit score, your property type e. non-construction property.
The debt to income ratio is very important to mortgage lenders as they use it to determine if you have way too many debts than you may be able to manage and if there is a potential that you could default on your mortgage and have your home repossessed.
When considering your debt to income ratio, mortgage lenders will want to see that you are:
Paying your monthly debts on time. Missed monthly payments will reduce your credit score.
Paying down existing debts over time
You have a low credit utilization. A high credit utilization may reduce your credit score.
You are not making too many credit applications for new types of credit. Too many credit applications may reduce your credit score.
You are not making late payments towards your debts.
When looking to get a mortgage you may find that some mortgage lenders may have a debt to income calculator. You can use the mortgage lenders debt to income calculator to see how much debt the mortgage lender may be willing to accept.
When looking to calculate your monthly debt repayments on your credit cards, most mortgage lenders will look to take into account your credit card repayments as 3% of any outstanding balance.
If you are a self-employed borrower then when calculating your monthly income you should be conscious that most mortgage lenders will not take into account 100% of your monthly income.
How to calculate your debt to income for your mortgage
Most mortgage lenders will want to have a low debt to income ratio as this will give them comfort that you will be able to keep up your monthly mortgage repayments without your debts making things much more stressful.
What is a good debt to income ratio for a secured loans?
Secured loans will usually allow you to lend more than you would be able to with a similar debt to income ratio on a mortgage. If you find that you’re unlikely to get a mortgage due to a high debt to income then getting a secured loan could be an option for you.
What is a good debt to income ratio for a personal loans?
Different personal loan lenders will all have their own different criteria but personal loan lenders tend to have the same level of cautiousness that many mortgage lenders have and you may find that getting a personal loan with a high debt to income ratio is very hard. You should speak to a mortgage broker to consider your mortgage options before seeking this route.
How does your debt to income ratio affect your ability to buy a house?
The debt to income ratio required to get a mortgage will differ from one mortgage lender to another and a mortgage broker may be able to help you get a mortgage regardless of your circumstances.
Most mortgage lenders will look to see your disposable income to determine how much you can afford in your monthly mortgage repayments per month.
Most mortgage lenders will want you to be able to comfortably to cover your monthly mortgage and still have enough room in your disposable income for financial emergencies.
What is a good debt to income ratio for a mortgage?
Usually mortgage lenders will want to see a debt to income ratio of less than 30% but most mortgage lenders will happily accept a debt to income ratio of 40% or more. A good debt to income ratio for a mortgage is hard to say as different mortgage lenders will have different requirements for their debt to income ratio requirements. If you are concerned about your debt to income ratio then speaking with a good mortgage broker who may be able to assist you further may be a good shout.
If you have a larger mortgage deposit then you may find that many mortgage lenders may still be willing to lend to you even with a high debt to income ratio.
Which debts do mortgage lenders count towards your debt to income ratio?
If you are not remortgaging then most mortgage lenders will count all your debts towards your debt to income ratio.
If you are remortgaging then it is possible that mortgage lenders will ignore your household debts.
The debts mortgage lenders will consider for your debt to ratio include:
Your credit card debts
Your student loans
Your personal loan debts
Your monthly mortgage repayments
When looking at your credit cards the mortgage lender will want to see that you are making your monthly credit repayments towards any outstanding balance. Mst mortgage lenders will also want to see that your credit utilization is low (as low as 30%) . If you are worried about how your credit balance will affect your mortgage application then speak to a mortgage broker.
Your student loans
If your student loans are now being paid every month then the mortgage lender may take this into consideration. Your student loans may not be represented on your credit file but the mortgage lender will ask you for this information on your mortgage fact find.
Your personal loan debt
Your personal loan debt will be taken into consideration by the mortgage lender to ensure you can afford to get a mortgage and maintain your monthly mortgage repayments. If the personal loan debt is a big chunk of your disposable income then it may be pushing your debt to income ratio so high. You may be able to reduce your debt to income ratio by refinancing your personal loan or consolidating your debts.
Your monthly mortgage repayments
If you are getting a remortgage then the mortgage lender may not consider your mortgage repayments towards your debt to income ratio. If you are getting an additional mortgage then the mortgage lender will consider your monthly mortgage repayments as part of your debt to income ratio.
Mortgage lenders will consider your debt to income ratio and if you have car finance then this will be considered by the mortgage lender.
Very short term loans such as payday loans will not be considered towards your debt to income ratio calculation but if it is a payday loan then you may find that very few mortgage lenders are willing to lend to consumers who have taken out payday loans.
Can you get a mortgage with a high debt to income ratio in the UK?
Yes, you can get a mortgage with a high debt to income ratio i the UK. There are many mortgage lenders who are available in the UK mortgage market and some will lend to borrowers who have a high debt to income ratio.
Some mortgage lenders will even lend to borrowers who have a debt to income ratio which is over 100%.
Mortgage lenders may pay more attention to the details surrounding the debts, when they end etc rather than the debt to income ratio itself.
Some mortgage lenders may also simply focus on the borrowers mortgage affordability requirements.
Some mortgage lenders may accept borrowers who have debt to income ratios above 100% but can keep up the monthly repayments on their mortgages through savings or similar means.
Can you remortgage with a high debt to income?
Yes you may be able to get a remortgage with a high debt to income if most of the factors causing you to have a high debt to income are your household costs including your monthly mortgage repayment, house insurance etc.
If your remortgaging to consolidate some of your debts then you may find that there are mortgage lenders out there who are willing to lend to you but the underwriting process may be much stricter.
Can you get a mortgage with a high debt to income and bad credit?
Getting a mortgage with bad credit would be hard enough as the mortgage lender may not be willing to lend to borrowers with bad credit. If you then have a high debt to income ratio as well then you may find it very hard to find a mortgage lender who is willing to lend to you.
Bad credit could include:
Missed credit account payments
Credit account defaults
A debt management plan
A home reposession
How much debt can I have and still get a mortgage?
Most mortgage lenders will expect you have very few debts when looking to get a mortgage but some mortgage lenders will have a debt to income ratio of 50%. This can be several different debt accounts but some mortgage lenders may also have a maximum cap on the number of debt accounts you can have open when looking to get a mortgage.
If you need financial advice and you live in the UK then you could contact the Money Advice service over the phone or via chat for impartial advice.
You can also contact the debt charity “Step Change” if you are in debt and need help.