If you're considering taking out a home loan, you need to know the rules regarding your DTI -- that's your debt-to-income ratio for mortgage loans. That's because your debt-to-income ratio is one of the key factors that determines loan approval.
The best mortgage lenders consider a number of criteria when deciding whether to approve you for a mortgage. However, your debt-to-income ratio for mortgage loans is especially important. Mortgage companies want to know you're not getting in over your head financially. If your debt-to-income ratio is too high, you may be denied a home loan. Even if you're accepted, you might have to pay a higher interest rate on your mortgage.
A debt-to-income ratio for mortgage loans is a simple ratio measuring how much of your income goes towards making payments on debt. You can calculate your DTI ratio by adding up the payments on the debts you owe and comparing that to what you earn.
Mortgage lenders use your pre-tax, or gross income, when calculating your debt-to-income ratio for mortgage approval. Your mortgage lender will also consider only the minimum required payments on your debt, even if you choose to pay more than the minimum.
For example, let’s say your gross monthly income is $5,000 a month and these are your debts:
Your total monthly debt payments including your credit card payment, auto loan, mortgage payment, and personal loan payment would be $1,225. Divide this by your monthly income of $5,000 and you'll see that your debt-to-income ratio for mortgage approval is 24.5%.
Many mortgage lenders consider two different debt-to-income ratios when they're deciding whether to give you a mortgage loan and how much to lend. The two ratios include:
Lenders generally consider both types of debt-to-income ratios; however, the back-end ratio is typically more important because it gives lenders a big-picture view of your finances.
If your housing costs will be a little bit high relative to your income but you have no other debt payment obligations at all, a lender may be more willing to lend to you. This is because your total financial obligations will still be manageable even with that bigger mortgage loan.
Typically, lenders want to see a front-end debt-to-income ratio of 28% and a back-end ratio of 36%. However, some conventional lenders will allow a back-end ratio of up to 43%. If you're able to obtain a loan through a program with government backing, such as an FHA loan, your back-end debt-to-income ratio could go as high as 50%.
The lower your debt-to-income ratio, the more likely you'll be to qualify for a loan at a favorable mortgage interest rate. This is especially if you have other positive factors, such as a good credit score.
Unfortunately, many people have too much debt relative to their income to qualify for a mortgage loan. High monthly loan payments can result in a debt-to-income ratio that's too high to obtain a home loan.
To improve your debt-to-income ratio for mortgage approval, you could try to earn more so you have a higher income relative to your debt. You can and should also try to pay down debt aggressively so you have less debt that counts toward your monthly financial obligations.
Buying a lower cost home could also help, as this could reduce your mortgage loan costs as well as costs for property taxes and insurance.
It's a good idea to know what your debt-to-income ratio is before you apply for a mortgage so you can make certain you're able to afford to borrow as much as you need.
If you don't make enough to qualify, you'll need to scale down your expectations for the amount you can borrow. Alternatively, you could pay off your other debts before applying for a home loan. Calculating your debt-to-income ratio for mortgage loans is easy: Just add up what you owe and compare it to your income and you'll figure out this important number.
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