If you’ve done any research into home loans, you know that lenders look at your debt-to-income ratio (or DTI) when considering your loan application. But what exactly is it, and how do you know what yours looks like? Here are a couple of tips for understanding your debt-to-income ratio and why it’s important to lenders.
What is a debt to income ratio?
Your debt-to-income ratio basically stacks your monthly debt (payments) against your gross monthly income, generally before taxes are taken out. Lenders look at this to evaluate whether you can actually handle another monthly payment on your budget. Your debt-to-income ratio is generally broken down into front-end and back-end:
- The front-end DTI ratio is sometimes called your mortgage-to-income ratio. It shows what percentage of your income would go to your housing should you get the loan, including your mortgage payment, insurance and taxes. Generally lenders will make sure your percentage is within standard limits before approving you for a loan,
- Back-end DTI tracks all monthly payments, including your credit card bill, car loans, etc. It looks at your finances even beyond your housing costs to see if your other debt obligations make it unlikely for you to be able to make your payments on a mortgage.
What are the limits?
For conventional loans, lenders typically recommend that your front-end ratio fall at no more than 28 percent. Your back-end should generally be 36 percent or lower. FHA loans, which are backed by the Federal Housing Association and aim to help first-time and low-income home buyers with less established credit, have lower maximums. It’s possible to get an FHA loan by maintaining lower than 41 percent for your back-end ratio, and 29 percent for front-end debt-to-income ratio.
How do I calculate my debt-to-income ratio?
Add up all your monthly payments, and divide them by your gross monthly income. This will give you your overall debt-to-income ratio, which industry standards recommend be under 43 percent total.
Remember that although you can calculate this on your own, your lender will be evaluating multiple aspects of your financial report, including your credit score and jobs held in the last 2 years. This is just to help you look at your monthly expenditure and see if you could make any adjustments that would help you be more financially ready to apply for a mortgage. We have tools to help you no matter where you are at, so give us a call!
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The Christian Mortgage Mom