Your debt-to-income ratio (DTI) is an important part of qualifying for a mortgage because it serves as an indicator of your financial capacity to repay the loan. A higher DTI means more risk for the lender, a lower DTI means less risk.

What Is DTI?

Your debt-to-income ratio is essentially the percentageof your monthly gross income that goes to housing expenses and servicing debts such as auto loans, credit cards, home loans (or rent), credit lines, etc.

If you have a high DTI, it indicates that you have tight finances and could have a tougher time keeping up with payments in event of unexpected expenses or a loss of income. If you have a very low DTI, lenders consider it much safer to lend to you because you have the extra cash flow to easily keep up with the payments even if you have a financial emergency.

The maximum debt-to-income ratio allowed today is 50% for FHA loans and 45% for conventional loans. In other words, for a conventional loan, no more than 45% of your monthly qualifying income can be spent on debt service and housing expenses, 50% for FHA-insured financing. The guidelines for FHA and conventional loans do sometimes allow for higher DTIs, but only on a limited basis and with compensating factors such as high credit scores, assets, low loan-to-value, etc.

When you\’re talking with your lender, you may hear the terms \”front end\” and \”back end\” DTI mentioned. \”Front end\” DTI refers to the percentage of your income that covers just your house payment, including taxes, insurance, mortgage insurance, and HOA fees. \”Back end\” DTI includes all housing and debt expenses.

Front end DTI isn\’t as big a concern as in past years, but it still does come up every now and then. Most lenders these days are concerned primarily with your back end DTI.

How to Calculate Your Debt to Income Ratio

To calculate your debt-to-income ratio, you simply divide your total monthly debt payments and rent or housing payments (including taxes, insurance, mortgage insurance, and HOA fees) by your gross monthly income, as follows:

1) Grab a recent copy of your credit report or your most recent account statements for all debts. Note that non-debt expenses (utility bills, phone, cable, etc.) are not part of your DTI, so don\’t worry about those.

2) Add up all your payments except for rent or mortgage for now. Make sure to include credit cards (use just the minimum payment), student loans, car loans, and any other debt obligations that you have.

3) Now add your rent or mortgage payment, including property taxes, homeowner\’s insurance, any mortgage insurance (PMI), and homeowner\’s association (HOA) fees.

4) Divide your total debt obligation figure by your gross monthly income, then multiply by 100 to get your debt-to-income percentage.

If you\’re planning to either purchase a home or refinance an existing mortgage and want to get an idea of your qualifying DTI for the new loan, substitute your existing rent or total mortgage payment (including taxes, insurance, HOA fees, and PMI) for the new estimated mortgage payment.

David Parker writes about real estate, mortgage, and real estate investing. Also check out his website about mortgage insurance at Definition of PMI.

David Parker writes about real estate, mortgage, and real estate investing. Also check out his website about mortgage insurance at Definition of http://www.definitionofpmi.com PMI.

Author Bio: David Parker writes about real estate, mortgage, and real estate investing. Also check out his website about mortgage insurance at Definition of PMI.

Category: Real Estate
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