Getting Pre-Approved for a Home Loan with a Lot of Debt

Reader question: "I have read your article about mortgage pre-approval, and I have a question that relates to it. I have a couple of credit cards that add up to about $13,000 in total balances. Do you think this is too much debt when buying a home? Can I get pre-approved for a home loan with high debt levels?"

I hate to use the 'D' word so often, but it depends. The lender will look at your total debt load in relation to your income. This is aptly referred to as your debt-to-income ratio, or DTI. So there's a key piece of information missing from your question: How much of your monthly income are you putting toward your monthly debts? This is the question you should answer before getting pre-approved for a home loan.

The Benefits of Getting Pre-Approved

You've reached a common stage in the home-buying process. You've been researching the process and considering your financial situation. Now you have questions about your qualifications as a borrower. Maybe you're not sure what to do next, aside from further research. I've seen many first-time buyers reach this same stage and come to a complete halt. So I'll tell you the same thing I tell them: It's probably time for you to speak to a lender.

This is the whole point of getting pre-approved for a home loan, in the first place. It helps you identify any obstacles that might prevent you from getting the loan. And having too much debt can certainly be an obstacle. When you apply for a mortgage, the lender will review several key piece of information. This includes the following items:

  1. Your current FICO credit score
  2. The amount of money your earn
  3. The total amount of debt you owe
  4. The relationship between items 2 and 3 above (DTI ratio)
  5. The amount of money you have for a down payment
  6. The amount of extra money you have in the bank (cash reserves)

They'll look at other things too, such as your employment history. But these are by far the six most important criteria when getting pre-approved for a home loan.

You will learn a lot from this process. For one thing, you'll find out if you have any barriers to approval. Is your credit score too low? Do you have too much debt relative to your income? Do you have insufficient funds for closing? You'll find out about these things when you get pre-approved.

And if you do meet the lender's criteria for approval, you'll also find out how much they are willing to lend you. Obviously, this is a crucial piece of information. You can't start house hunting until you know how much of a home loan you can get.

Debt Can Hurt You in Two Ways

As a home buyer, having a lot of debt can hurt you in two ways. It can lower your FICO credit score, and it can increase your debt ratios. Both of these things will decrease your chances of getting approved for the loan. So let's talk about them in more detail.

The FICO scoring system uses five categories of information to determine a person's score. Your "utilization ratio" is one of them. This ratio shows how much money you owe in the form of debt. It compares your credit card balance(s) to the available limit on the card(s). For example, if you are using three-fourths of your available credit limit, then your utilization ratio is 75 percent. The higher the ratio, the worse it is for your FICO credit score.

That's one way a large amount of debt can hurt you when getting pre-approved for a home loan. But it's not the only way. It also drives up your debt-to-income ratios. As we discussed earlier, these ratios are a key part of the mortgage-approval process.

You actually have two different ratios. One is more important than the other:

  • Front-end ratio: This is also referred to as your housing expense ratio. It's a comparison between your gross monthly income and your monthly housing costs (mortgage payment, property taxes and homeowners insurance). Most lenders prefer this number to be below 29 percent.
  • Back-end ratio: This is the one lender's care about the most. In includes your housing expenses in addition to your other debts (car payment, credit cards, etc.). This number gives lenders a more accurate picture of how much combined debt you'll have, if and when you take on the new mortgage. Most lenders prefer to see a back-end ratio below 41 percent. They'll tell you what their limits are when you get pre-approved for the loan.

To calculate your back-end ratio, you would divide your total monthly debt expense by your gross monthly income. Then multiply by 100. For example, let's say I earn $7,500 a month before taxes (gross). After taking on the mortgage loan, I would be spending about $2,500 a month on my total debts. So I divide 2,500 by 7,500, and then multiply by 100:

2500 / 7500 = .33 x 100 = 33

My back-end debt ratio in this scenario would be 33 percent. This is a manageable level of debt, from a lender's perspective. So it should not present any problems for me.

You can calculate your own ratio right now, before you get pre-approved for a home loan. It's an easy way to find out where you stand. All you have to do is add up your monthly debts, including your credit cards. Then plug in your gross monthly income, as I've done above.

Tip: When measuring your debt, the lender will use anything that shows up in your credit reports. This will include car payments, student loans, credit cards, retail charge cards, etc. If you want to know which debts are showing up, you should check your reports.

Like I said before, it really depends on how high your debt is in relation to your gross monthly income. You can calculate that using the example I've given above. But don't take these numbers as gospel. The debt limits for a mortgage loan will vary from one lender to the next. It's also one of the rules they are willing to bend, if you are strong in other areas. For example, if you have a good credit score and a large down payment, they'll probably be more lenient with the debt ratios.

Related article: How to Apply for a Mortgage Loan

This article explains the process of getting pre-approved for a home loan, and how your debt ratios tie into this process. You'll find dozens of related articles on this website. Use the search tool at the top of this page to continue your research.