Your debt-to-income ratio (DTI) is an important part of qualifying for a mortgage because it serves as an indicator of your financial capacity to repay the loan. A higher DTI means more risk for the lender, a lower DTI means less risk.
What is a Debt-to-Income Ratio?
Your debt-to-income ratio is essentially the percentage of your monthly gross income that services debts (auto loans, credit cards, credit lines, etc.) as well as housing expenses (mortgage payments, including taxes and insurance, HOA fees, rent, etc.).
If your DTI is high, it means you have very little excess cash to handle unexpected expenses and keep up with your mortgage payments, which represents increased risk for the lender. On the other hand, if your DTI is low, you have plenty of extra cash flow on a monthly basis to easily make your payments and cover the unexpected.
The maximum debt-to-income ratio allowed today is 50% for FHA loans and 45% for conventional loans. In other words, for a conventional loan, no more than 45% of your monthly qualifying income can be spent on debt service and housing expenses, 50% for FHA-insured financing. The guidelines for FHA and conventional loans do sometimes allow for higher DTIs, but only on a limited basis and with compensating factors such as high credit scores, assets, low loan-to-value, etc.
When you're talking with your mortgage consultant, you may hear him mention "front end" or "back end" DTI. "Front end" DTI refers to the percentage of your qualifying income that goes just to your house payment, including taxes, insurance, HOA, and mortgage insurance. "Back end" DTI includes all debt and housing expenses.
Front end DTI isn't quite as important as it used to be, but it is still a consideration under some circumstances. Most lenders are concerned primarily with your back end DTI.
How to Calculate DTI
To calculate DTI, simply divide your total monthly debt payments and rent or housing payments (including taxes, insurance, mortgage insurance, and HOA fees) by your gross monthly income, as follows:
1) Grab your credit report or most recent statements for all debt obligations. Note that non-debt expenses, such as utility bills, phone, cable, etc., are not included in your DTI.
2) Sum up all payments except for rent or mortgage for the moment. Make sure you include all credit cards (use just the minimum payment), installment loans, auto loans, student loans, and any other debt obligations that you have.
3) Now add in your home mortgage payment (or rent), including property taxes, homeowner's insurance, homeowner's association (HOA) fees, and private mortgage insurance (PMI) premiums.
4) Divide your total debt obligation figure by your gross monthly income, then multiply by 100 to get your debt-to-income percentage.
If you're looking to purchase a house or refinance your existing mortgage and want to determine your DTI for the new mortgage, substitute your existing rent or mortgage payment (including all taxes, insurance, mortgage insurance, and HOA fees) for the new estimated mortgage payment.
What is a Debt-to-Income Ratio?
Your debt-to-income ratio is essentially the percentage of your monthly gross income that services debts (auto loans, credit cards, credit lines, etc.) as well as housing expenses (mortgage payments, including taxes and insurance, HOA fees, rent, etc.).
If your DTI is high, it means you have very little excess cash to handle unexpected expenses and keep up with your mortgage payments, which represents increased risk for the lender. On the other hand, if your DTI is low, you have plenty of extra cash flow on a monthly basis to easily make your payments and cover the unexpected.
The maximum debt-to-income ratio allowed today is 50% for FHA loans and 45% for conventional loans. In other words, for a conventional loan, no more than 45% of your monthly qualifying income can be spent on debt service and housing expenses, 50% for FHA-insured financing. The guidelines for FHA and conventional loans do sometimes allow for higher DTIs, but only on a limited basis and with compensating factors such as high credit scores, assets, low loan-to-value, etc.
When you're talking with your mortgage consultant, you may hear him mention "front end" or "back end" DTI. "Front end" DTI refers to the percentage of your qualifying income that goes just to your house payment, including taxes, insurance, HOA, and mortgage insurance. "Back end" DTI includes all debt and housing expenses.
Front end DTI isn't quite as important as it used to be, but it is still a consideration under some circumstances. Most lenders are concerned primarily with your back end DTI.
How to Calculate DTI
To calculate DTI, simply divide your total monthly debt payments and rent or housing payments (including taxes, insurance, mortgage insurance, and HOA fees) by your gross monthly income, as follows:
1) Grab your credit report or most recent statements for all debt obligations. Note that non-debt expenses, such as utility bills, phone, cable, etc., are not included in your DTI.
2) Sum up all payments except for rent or mortgage for the moment. Make sure you include all credit cards (use just the minimum payment), installment loans, auto loans, student loans, and any other debt obligations that you have.
3) Now add in your home mortgage payment (or rent), including property taxes, homeowner's insurance, homeowner's association (HOA) fees, and private mortgage insurance (PMI) premiums.
4) Divide your total debt obligation figure by your gross monthly income, then multiply by 100 to get your debt-to-income percentage.
If you're looking to purchase a house or refinance your existing mortgage and want to determine your DTI for the new mortgage, substitute your existing rent or mortgage payment (including all taxes, insurance, mortgage insurance, and HOA fees) for the new estimated mortgage payment.
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Also check out: What is LTV and why does it matter for a mortgage shopper? And do credit inquiries really harm credit scores?
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