When it comes to getting a mortgage, there are a few numbers that are important to the process. Chief among those is your credit score, which is a numerical value that signifies how good you are at meeting your financial obligations.
Another of those important numbers is your debt-to-income (DTI) ratio. DTI ratio is a figure that represents how much of your monthly gross income (your income before taxes) goes to paying your monthly debt and other accounts.
Along with your credit score and other information, lenders consider your DTI ratio when determining whether you’re capable of taking on a loan.
What is DTI ratio?
Your DTI ratio is determined by adding all your monthly debt payments together and dividing that by your monthly income before taxes.
There are two types of DTI ratios that mortgage lenders use when examining your credit situation: front-end DTI and back-end DTI.
A front-end DTI ratio is a calculation related to the house you’d like to buy and the mortgage you’d need to buy it. Front-end DTI uses your monthly gross income to determine what percentage of that would go toward your housing costs, including your projected monthly mortgage payment, property taxes, homeowner’s insurance, mortgage insurance, and homeowner’s association fees.
A back-end DTI ratio is more of a picture of your current debt situation. Back-end DTI shows how much of your income is needed to cover all of your monthly debt liabilities combined, including any credit card debt, car payments, child support, student loans, current monthly mortgage payment, and other debt amounts that may appear on your credit report.
How is DTI calculated?
To determine your back-end DTI ratio, add up all those monthly expenses listed above (if applicable) and any other recurring monthly expenses that aren’t listed and divide that number by your gross monthly income. If you’re unsure about what gross monthly income is, it’s the amount that you earn each month before taxes and other deductions are taken out of your paycheck.
It’s very important to know that your DTI ratio does not include or acknowledge how much you spend each month on items that don’t appear on your credit report, including living expenses like groceries, and entertainment.
Let’s look at an example. Let’s say your monthly gross income is $6,000 and your monthly recurring expenses are $2,000. To calculate your back-end DTI, divide $2,000 by $6,000 and you get a DTI ratio of 33.3%.
What is the ideal debt-to-income ratio?
A low DTI ratio indicates a good balance between debt and income. In general, the lower the DTI percentage is, the more likely you are to get the loan amount that you want. If your DTI ratio is on the higher side, you may have too much debt for your income (in the eyes of a lender).
Lenders typically say the ideal front-end DTI ratio should be no more than 28%. For the back-end ratio, lenders say it should be 36% or lower.
It’s important to keep in mind that lenders may accept higher DTI ratios depending on what type of loan you’re trying to apply for and other factors like what your credit score is, how much savings you have, and the amount of down payment you’re going to provide.
Of course, if your DTI is on the lower end of the scale, you have a better chance of being approved for a mortgage. You may also be more likely to qualify for a lower mortgage rate. You can use our home affordability calculator to help estimate how much house you can afford based on your income and monthly expenses.
How can you lower your debt-to-income ratio? To put it simply, there are two ways to lower your DTI ratio. You either need to lower your debts or increase your income. You can lower your monthly recurring debt by paying off existing debts and by not taking on any more debt than you have currently.
Another way to lower your DTI ratio is to increase your gross monthly income, perhaps by working as a freelancer in your spare time or by finding a new job that pays more than your current job.
If you’re interested in learning more about mortgages, our Loan Officers are a great resource who can help you with any questions that you may have.
Contact our team today. We’re here to help you every step of the way through your loan process.