Debt to Income Ratio | Mortgage Process Explained

When underwriting a mortgage, lenders try to understand whether or not you’ll be able to afford your new mortgage payment. They care more about your monthly debt payments than they do your total amount of debt. To understand your ability to repay your debt, lenders will check your debt-to-income ratio.

Debt-to-income ratio defined

Also known as a DTI ratio, this is a monthly analysis of how much of your income goes towards paying your debts. For a mortgage to be affordable, there needs to be enough room in your monthly budget to cover your living expenses and still satisfy the debt payments for your credit cards, mortgages, and any other debts you might have.

There are two ways to calculate your DTI ratio:

  • Front end debt-to-income – This is your housing expenses (mortgage, property tax, home insurance, etc.) divided by your gross income.
  • Back end debt-to-income – All of your monthly debt obligations (auto loans, student loans, credit card payments, housing expenses, etc.) divided by your gross income.

The back-end DTI is the important number here. Most lenders won’t originate a loan if the back end DTI is over 43%. Said another way, all of your debt payments combined shouldn’t be more than 43% of your gross income. In some cases, you can qualify for a loan all the way up to a 50% DTI ratio, but you’ll need to meet certain criteria for that to be an option. For example, you’ll need to have a certain amount of cash saved as reserves after your cash to close is transferred to escrow.

Even then, most lenders want to see you well below 50%. The Consumer Finance Protection Bureau has a pretty good explanation why.

What is a good debt to income ratio?

A good rule of thumb is to shoot for the 30-35% DTI range. This will give you more flexibility when shopping for a home – if you find a home in this range, your low DTI ratio will make getting approved for a home loan much easier. And if you fall in love with a home at the top end of your range, you will have some wiggle room to increase your loan amount and purchase the home.

 

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