Debt-to-Income Ratio (or DTI) is a personal finance measure that compares the amount of debt you have to your overall income.
Mortgage lenders use it as a way to measure your ability to manage the payments you make each month and repay the money you have borrowed.
When you apply for a mortgage, you’ll need to meet maximum DTI requirements so your lender knows you’re not taking on more debt than you can handle.
Lenders prefer borrowers with a lower DTI because that indicates less risk that you’ll default on your loan.
A mortgage debt-to-income ratio leaves out monthly expenses such as food, utilities, transportation costs and health insurance. Although lenders may not consider these expenses and may approve you, it’s important not to borrow more than you’re comfortable paying.
So keep these additional obligations in mind as you evaluate how much you’re willing to pay each month.
Understanding Debt-to-Income Ratio
A low debt-to-income ratio demonstrates a good balance between debt and income. In general, the lower the percentage, the better the chance you will be able to get the loan or line of credit you want.
On the contrary, a high debt-to-income ratio signals that you may have too much debt for the income you have, and lenders view this as a signal that you would be unable to take on any additional obligations.
To a lender, someone with a high debt-to-income ratio can’t afford to take on any additional debt…and if the borrower defaults on his mortgage loan, the lender would lose money.
How High Can You Go?
Evidence from studies of mortgage loans suggest that borrowers with a higher debt-to-income ratio are more likely to run into trouble making monthly payments. A 43 percent debt-to-income ratio is important because, in most cases, that is the highest ratio a borrower can have and still qualify for a loan backed by Fannie Mae and Freddie Mac.
Larger lenders may still make a mortgage loan if your debt-to-income ratio is more than 43 percent, but they will have to make a reasonable, good-faith effort, following regulatory rules, to determine that you have the ability to repay the loan.
Calculating Debt-to-Income Ratio
To calculate your debt-to-income ratio, add up your total recurring monthly obligations (such as mortgage, student loans, auto loans, child support, and credit card payments), and divide by your gross monthly income (the amount you earn each month before taxes and other deductions are taken out).
For example, assume you pay $1,200 for your mortgage, $400 for your car, and $400 for the rest of your debts each month. Your monthly debt payments would be as follows:
- $1,200 + $400 + $400 = $2,000
If your gross income for the month is $6,000, your debt-to-income ratio would be 33% ($2,000 / $6,000 = 0.33). But if your gross income for the month was lower, say $5,000, your debt-to-income ratio would be 40% ($2,000 / $5,000 = 0.4).
Your debt-to-income ratio (DTI) – how much you pay in liabilities each month compared to your gross monthly income – is a key factor when it comes to qualifying for a mortgage. Your DTI helps lenders gauge how risky you’ll be as a borrower.
Keeping your debt-to-income ratio low can help you qualify for a home loan and pave the way for other borrowing opportunities. It can also give you the peace of mind that comes from handling your finances responsibly.
Please do reach out to me for more, as it would by my pleasure to help you qualify for a mortgage!
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