Understanding Debt-to-Income Ratio
BY: Gretta Stilson
Are you thinking of purchasing a home in 2021? If so, it's important that you understand your debt-to-income (DTI) ratio. Along with credit score and down payment amount, it's one of the most critical factors that mortgage lenders use to determine whether a borrower is eligible to be approved for a new-home purchase.
DTI ratio measures the size of one's monthly debt relative to the size of their monthly gross pay. Boiled down to its most basic elements, it helps lenders decide whether someone is capable of taking on another loan. If you're worried that you have too much debt to buy a house, read on.
You can calculate your DTI ratio by dividing your recurring monthly obligations (e.g., your minimum credit card, student loan, and child support payments) by your gross (i.e., pre-tax) monthly income. When your lender calculates it, that percentage will include your potential new house payment, taking into account monthly principal and interest, real estate taxes, homeowners insurance, and any applicable mortgage insurance premiums.
It's important to note that DTI ratio doesn't consider the amount of money you’re using to pay for living expenses, such as groceries, phone bills, life insurance premiums and car insurance. Even if you think you can afford to take on a mortgage, you’ll need to determine how those things will impact your entire budget.
The maximum DTI ratio that a homebuyer can have typically is 50% (up, recently, from 45%), if he or she wants to take out a mortgage and also be approved for mortgage insurance. Lender want to lend money to homebuyers with low debt-to-income ratios. Any ratio higher than 50% suggests that a buyer could be a risky borrower and the mortgage could potentially go into default.
Potential buyers should, ideally, only have a small amount of debt relative to the their monthly income. If you’re trying to qualify for a mortgage, it’s best to keep your debt-to-income ratio below the 35-40% range. You’ll improve your odds of getting approved with better loan terms if you do.
Our home-lending professionals can review your situation to determine how much house you can afford, as well as offer advice on which loan program makes the most sense for you. With us, you'll have the peace of mind of knowing that you're purchasing the right home with the right terms. Reach out to me or one of our many lenders today!