The home buying process is more than simply shopping for a two-story house with a pool and an updated kitchen — you may also need to apply for a mortgage to purchase a home. There are several types of loans available for a new home purchase, including an FHA loan. However, to obtain a home loan, you must meet specific qualifications, one of which may be your debt-to-income ratio for mortgage purposes, also referred to as your DTI.
Understanding your DTI and how it relates to applying for a loan and buying a house can help ensure the homes you shop for are within your budget. It’s also important to know about the hidden costs in addition to your mortgage so your home purchase doesn’t make it impossible to afford basic necessities. Your mortgage debt-to-income ratio is not only important for your lender; it can also help you to better understand your financial situation, so you don’t get in over your head when buying a home.
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Maximum Debt-to-Income Ratio For a Mortgage
You can calculate your DTI by dividing your current monthly expenses by your gross monthly income. Your maximum debt-to-income ratio for mortgage purposes is calculated slightly differently. It gives your lender a better idea of your current debt and how your mortgage payment will affect your household budget.
Essentially, this calculation is a way for the loan provider to determine if you have the ability to pay the mortgage while still meeting your other financial obligations. When calculating your DTI, lenders will look at both the front-end and back-end ratio.
Front-End Ratio
When calculating your debt-to-income for mortgage terms, a lender will first find your front-end ratio, or the housing ratio. This number isolates your housing debt, or the amount you’ll pay monthly for your rent or mortgage.
For example, say you applied for a home loan that will result in $1,500 monthly mortgage payments and you currently earn $6,000 in gross monthly income. You can divide your gross monthly income into your potential mortgage payment to get your mortgage debt-to-income for your front end ratio, which is 25%.
Back-End Ratio
The back-end ratio takes into account all of your monthly debt obligations, including your mortgage payment. This more comprehensive DTI calculation analyzes the income that goes toward debt, mortgage, and housing expenses. This includes your credit card bills, student loans, child support, and other forms of revolving debt.
Some lenders choose to only use your back-end ratio to determine if you qualify for a home loan. Since this calculation encompasses your entire household DTI, it’s a more inclusive way to better understand how a mortgage will affect your financial situation. However, in some cases, a lender will look at both DTI calculations to decide whether or not you qualify for a mortgage and the terms you’ll be offered.
Most lenders prefer a front-end ratio DTI calculation of 28% or less. However, depending on your down payment, the type of loan you’re applying for, and your credit history, you may still qualify with a higher DTI. When analyzing your back-end debt-to-income ratio for mortgage terms, most lenders prefer 36% or less.
How to Lower Your DTI
If you find your DTI is too high to qualify for a loan you feel comfortable with, you may need to take some time to focus on lowering it before purchasing a home. To lower your DTI, you can increase your income, lower your expenses, or both. Consider getting a side gig in addition to your current full-time job, such as bartending or mowing lawns.
Analyze your current household budget and lower expenses where you can. Reduce the number of times you and your family eat out each week or consider working out at home instead of paying for your monthly gym membership. These small changes can add up and positively transform your financial situation. In turn, this can lower your DTI and allow you to qualify for the mortgage you want.
Mortgage DTI Calculator
Calculating your own DTI can be complex and it’s easy to forget to include certain monthly expenses, such as homeowner’s insurance or HOA fees. You can use an online mortgage calculator to help you learn how a mortgage will affect your monthly budget.
Qualifying For a Mortgage
Meeting the maximum debt-to-income ratio for mortgage terms is just one of the steps necessary to qualify for a mortgage. There are many other factors a lender will consider when deciding if you qualify for a mortgage and determining your loan terms, including:
- The down payment amount you can provide.
- The qualifying income you earn.
- Your credit history and score.
- Current assets you have.
- Your ability to provide proof of employment.
- Your financial statements.
Your DTI is used by lenders to verify your eligibility for a loan but you can also use it to analyze your own financial situation. This calculation allows you to see how the addition of a mortgage affects your monthly budget. Even if you’re approved for a home loan, use your DTI to ensure you feel comfortable with your new monthly budget before accepting the loan terms.
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