When you're looking for a new home, you're likely taking a crash course in new mortgage and finance terms. Debt-to-income ratio, which compares your monthly debt payments to your income, is a common one. Lenders assess your debt-to-income ratio for a mortgage to evaluate your financial ability to take on a new loan.
A debt-to-income ratio compares your monthly debt payments to the amount of income you generate. When you apply for a mortgage, a lender may ask you to list your current debt and income on the application.
The lender will use those amounts to calculate your DTI. This ratio helps determine if you can handle the anticipated mortgage payment while still keeping up with other monthly payments. While reviewing your debt-to-income ratio for a mortgage is common, lenders may also consider this ratio when approving an auto loan, new credit card or personal loan.
Lenders take your DTI into account when deciding if you can afford to purchase a home. If your DTI exceeds their preset guidelines, you may not be approved for a mortgage. Getting preapproved for a mortgage can help you set a homebuying budget and ensure you feel comfortable when making an offer to a seller.
Leverage your existing banking relationships when seeking a new loan. If you have a savings or checking account, stop by your local branch and ask about mortgage programs for existing bank customers.
You might find it helpful to know your debt-to-income percentage before you apply for a loan. To further evaluate your financial position, lenders may calculate two different ratios, known as HTI or housing to income ratio and back-end DTI:
Make a list of every outstanding loan and the amount you must pay each month. Student loans and car loans count as debt. So do credit cards, even if you always pay the balance in full. You may notice slight variations between different lenders' calculations of DTI, but generally, these amounts are considered debt:
You don't need to include amounts such as:
Before you finalize the debt portion of your DTI, you may want to request a free credit report to avoid missing any outstanding balances. If you're the cosigner or the co-borrower on a loan, the outstanding amount owed may also affect your debt-to-income calculation, even if you don't make the monthly payments.
Use your gross monthly income — your total income before taxes and other deductions — when calculating your debt-to-income ratio.
Divide your monthly debt payments (step 1) by your monthly gross income (step 2). To calculate your front-end DTI, use only your monthly housing payment amounts. For a back-end DTI, include all types of debt. Lenders may also use your new mortgage payment in these calculations to make sure you meet their approval guidelines.
Staying within these ranges demonstrates to the lender that you are well equipped to meet your ongoing financial obligations while still leaving room in your budget for living expenses and unexpected events. If you’re applying for something new such as a car loan or a credit card, it helps to understand what's considered the ideal debt-to-income ratio.
While you may be approved for a mortgage or other type of loan with a back-end DTI higher than 36%, the lender may not offer you the best interest rates and terms. First-time buyers or others who don't meet the 36% target may want to ask their lender about government-backed mortgages, such as an FHA loan, with higher DTI thresholds.
Plan how to improve your DTI. If you'd like to buy a home in the next year, take steps to start paying down your debt today. Consider the timing of other large purchases, such as a new car, that may affect your DTI.
If your DTI exceeds the lender's guidelines, you can take steps to bring the percentage down to an acceptable range. You can lower your debt-to-income ratio in three ways: increase your income, pay down your debt or consider purchasing a less expensive home with a lower mortgage payment.
Ways to increase your income:
Ways to pay down your debt:
No, DTI and credit scores are separate calculations that lenders use to evaluate if you can pay back loans. However, both DTI and credit scores use information found on your credit report. DTI factors income into the calculation, but your credit score does not. Both credit scores and DTI may improve as you pay off existing debt shown on your credit reports, such as credit card balances or auto loans.
If you're currently leasing an apartment, your monthly rent is typically included in your debt-to-income ratio. Your housing payment is considered a necessary expense, even if you rent. If you've signed a lease for an apartment or condo, you're committed to paying the rent each month, just like your monthly mortgage or student loan payments.
Backed by the federal government, Federal Housing Administration loans offer financing assistance to homebuyers with lower credit scores or smaller down payments. Most borrowers need a DTI of 43% or less to qualify for an FHA loan. In some extenuating circumstances, such as a buyer with a large down payment or significant income, the DTI ratio for an approved FHA loan may be higher.
To calculate DTI, lenders use gross income (income before taxes and any additional deductions).
When calculating monthly debt for the DTI, include only the minimum balance for credit cards, even if you pay the total balance each month.
Your debt-to-income ratio is one of many items on your mortgage application that help determine whether you can afford to buy a home. Before submitting a bid on a property, consider your existing monthly payments and current savings balances as well as your short- and long-term financial goals.
Programs vary, and some mortgage lenders may work with slightly different approval guidelines. But even if you qualify for a mortgage with a higher DTI, weigh your personal comfort level when taking on a new loan. Will the mortgage require you to cut too much from other areas of your household budget? Or will your current income easily cover a larger housing payment?
Before you start house hunting, sit down with a loan officer in your local area to discuss which type of mortgage may work best for you. Many banks offer specialized programs for first-time buyers.
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