Are you considering applying for a home mortgage? Whether it's a new house loan or you want to refinance an existing home loan, one of the most important qualification factors is the debt-to-income ratio (DTI). What is this ratio? How can you calculate yours? And what details should you know about it? Here are some answers to your burning questions.
What Is the Debt-to-Income Ratio?
The debt-to-income ratio is a calculation that tells a lender how much debt you carry in relation to your income. It expresses your minimum mandatory debt payments as a percentage of your total gross income. For instance, if you must pay at least $500 in debt each month and make $2,000, your debt-to-income ratio is 25%.
In general, the ratio includes debts like credit cards, auto loans, secondary home loans, student loans, co-signed loans, and personal loans.
What Are the Front and Back-End DTIs?
Within the DTI category, there are two specific calculations. The first is called the front-end ratio. This is the percentage of gross income that goes to pay for your housing obligations: mortgage principal, interest, taxes, and insurance (PITI). Different lenders and different loan types have different maximum allowable percentages for overall housing cost — to avoid a person taking on too large of a house payment for their means.
The back-end ratio combines housing debt and all other debt to calculate the overall ratio of debt to income. Lenders will often look at both targets. They may express this as a combination number. For instance, if your lender uses 28/36, the goal is to spend less than 28% of income on housing debt and 36% of income on total debt.
How Can You Improve Your Ratio?
Is your DTI higher than you want? Could it impact your ability to get a house loan? If so, now is the time to take some effective steps.
There are three main ways to do this. First, you can boost your gross income, which results in a lower percentage with the same debt load. More commonly, borrowers work to get their non-mortgage debts paid down until they reach the desired percentage. The third option — specifically if your front-end ratio is high — is to adjust the type of house property you're looking for.
Where Can You Learn More?
Want help calculating your DTI? Do you have other specific questions pertinent to your own financial situation, such as self-employment or unusual debts? Start by learning more in consultation with a home loan service in your state today.
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