Your Debt-To-Income Ratio
Your debt-to-income ratio (DTI) compares how much you owe every month to the total amount you earn every month. Lenders may consider your debt-to-income ratio along with credit scores and credit reports when determining your eligibility for a loan. Your DTI never affects your credit report or credit score because income is never reported on your credit. However, many lenders will calculate your DTI when deciding whether or not to offer you a loan. They look at your DTI because it is considered an indicator of whether you'll be able to repay a loan. A low DTI indicates you might be more capable of repaying a loan because you make much more than you owe. Alternatively, if you already have a high DTI, you may struggle to repay any new loans. So, when you’re considering purchasing a home knowing your debt-to-income ratio can help you get the loan you want.
Calculating your Debt-To-Income Ratio
In order to calculate your DTI, you must first know your total recurring monthly debt. This is how much you spend every month on credit card payments, mortgages, your car loan, etc. Then you need to know your gross monthly income. Your gross monthly income is the total amount you make each month before taxes, withholdings, and expenses. Divide your total recurring monthly debt by your gross monthly income and the result is your debt-to-income ratio. Let's say for example, your total monthly debt is $4,000, and your gross monthly income is $8,000. In this scenario you would divide $4,000 by $8,000 to get a DTI of .5 or 50%.
What's a Good Debt-to-Income Ratio?
Typically, in order to qualify for a home loan your debt-to-income needs to be below 43%. Some lenders may even prefer ratios below 36%. In fact, the lower your DTI, the better the better your chances of getting approved for a home loan will be.
There are also two basic types of DTIs. They are front-end and back-end. Front-end DTIs only only compare how much of your gross income goes toward housing costs. That includes mortgage payments, property taxes and homeowner's insurance. Back-end DTIs look at gross income compared to all monthly debt payments. That includes housing, student loans, credit cards, automobile loans, and any other type of debt. If you are applying for a home loan, many lenders will prefer a front-end DTI of less than 28%. Furthermore, in order to qualify for an FHA loan, you will need a front-end ratio of less than 31%.
Improving Your Debt-to-Income Ratio
When you apply for a mortgage the lender will look at several key things. They will look at your debt-to-income ratio, your credit history, and your current credit scores. All of this information helps them determine how likely it is for you to be capable of repaying your loan. Improving your debt-to-income ratio can make a difference in how lenders view you when you apply for a home loan. There are several ways in which you can lower your debt-to-income ratio. There is no immediate way to improve your credit score or DTI. However, certain actions can help and get you on a better path. Firstly, you need to reduce your total debt. Pay off or pay down credit cards and any other loans that you possibly can. Avoid taking on new debt while preparing to apply for your home loan. It’s not easy, but if possible, try to improve your income. Ask for a raise, get a second job or perhaps even consider finding a new job that pays more. All of these things take time, but can definitely help you in the long run.
Final Thoughts
A low debt-to-income ratio is necessary in qualifying for a home loan. Calculate your DTI prior to applying for your home loan so that you have an idea of where you stand. Taking the necessary steps to lower your DTI and raise your credit score may help you qualify. Once your credit score and debt-to-income ratios are where they need to be, you are ready to begin the loan process. However, do not wait until you have good credit or the perfect DTI to reach out to a mortgage broker. You should do this several months before you think you want to apply for a mortgage. Experienced mortgage professionals can let you know the exact steps you can take to get to where you need to be. Peoples Choice Mortgage will help you get the right loan for you so you can buy that dream home.