Debt to income ratio for mortgage
If you’re planning to buy a new home, one of the first things that might pop into mind is whether you can get approved and afford it. When you submit your mortgage application, your lender will check whether or not you qualify. One of the critical factors they will tend to consider to determine your eligibility for a mortgage is your debt-to-income ratio, or DTI. Your DTI percentage shows the amount of your income that goes towards debt repayment, giving your lender an idea of how well you will be able to handle your mortgage payments.
Your debt-to-income ratio is as straightforward as it sounds: It’s the total amount of your debts versus your income stream. Your DTI calculates the percentage of your monthly income that goes into paying your debts (such as student loans, income tax, and mortgage) divided by your gross income. Your DTI helps a lender know whether granting you a mortgage would be a good decision or not. If your DTI is too high, lenders may reject your credit application.
Recognizing what you can comfortably afford and how your debt-to-income ratio affects your borrowing health is crucial. Look to your DTI mortgage percentage to determine the feasibility of being approved to take out a new loan or buy a home. Keep in mind that your DTI percentage should also signal, to you and to your lender, whether you have the means to take on and consequently repay an additional monthly payment.
What is included in the debt-to-income ratio?
Certainly monthly obligations are included in your DTI and debt-to-income ratios come in two forms: front-end DTI and back-end DTI. Your lender will likely look at both when considering your mortgage application.
A front-end debt-to-income ratio reflects your housing debt versus your monthly income. Your monthly debt for front-end DTI includes your real estate taxes, mortgage payment, interest, and insurance.
A back-end debt-to-income-ratio compares all of your monthly debts to your income. Your monthly debt for back-end DTI includes car loans, student loans, credit card payments, co-signed loans, child support, and alimony.
Neither DTI calculation factors in your everyday living expenses. You won’t have to worry about your grocery expenses, entertainment cost, utilities, etc. when you calculate your debt-to-income ratio. However, even though a lender won’t look at your lifestyle expenses when calculating your DTI, you should still take this monthly spending into account when you consider a new mortgage.
How to calculate your DTI
You need a low debt-to-income ratio not only to qualify for a mortgage but also to become financially stable. Not only does a high DTI mean that you’ll likely struggle to get a mortgage, it’s also a good indication that you’re struggling financially. Avoid taking on unnecessary expenses or you could end up in a debt trap that you can’t get out of.
Before applying for a mortgage, take the time to sit down and analyze your monthly obligations that a lender would consider in order to calculate your DTI. You may be stunned at how high or how low your numbers are.
Remember that your debt-to-income ratio compares how much you’ve borrowed each month in comparison to what you earn. To calculate your overall DTI, start by adding up all your recurring monthly payments. Include your mortgage as well as other recurring debts like student loans, minimum credit card payments, auto loans, and child support. Make sure that you account for any future obligations as well.
Next, determine your gross pre-tax monthly income. To calculate your gross income, add up all your wages, tips, bonuses, alimony, and additional income.
Now, divide your recurring monthly debt obligations by your gross pre-tax monthly income. The resulting percentage is your DTI, representing the percentage of your income that goes to repaying debts each month.
This is the percentage your lender will use to get an idea of your debt management and predict your ability to pay your mortgage loan to term. The lower the DTI, the fewer risks lenders will have to take.
What is a Good Debt-to-Income Ratio for a Mortgage?
Surprisingly, the accumulation of debt isn’t what overwhelms households in America. Instead, it’s the way debts grow compared to salaries. And while the ability to control spending comes naturally to some, others need to work hard to achieve a balance between paying debts and earning a decent income.
This leads to the question: What do lenders consider to be a good debt-to-income ratio?
Mortgage lenders are stringent when it comes to DTI. Most mortgage lenders consider 36% and lower to be a good debt-to-income ratio. Not more than 28% of your DTI should go toward your mortgage.
Every lender has different qualifications, and you could obtain a mortgage with a higher DTI. However, if you have a higher DTI, your lender may require additional eligibility criteria. You have an opportunity to improve your DTI. There’s room to improve between, say, a 36% DTI and 49% DTI. Consider paying down your debts or boosting your income for a better financial situation and better chances at securing a mortgage.
Make it a routine to calculate your debt-to-income ratio at regular intervals to keep an eye on your financial standing. Knowing your DTI can help you understand your finances and whether you’re in a good position to apply for a mortgage before you ever even submit your application to your lender.
Contact the Cain Mortgage Team to help you get your application off on the right foot.