Home shoppers wanting to qualify for a home loan may get declined because of a number they’ve never heard of: their debt to income ratio (DTI). If you’re a lttle bit hazy on Debt to Income Ratio (DTI), you’re in good company. According to Fannie Mae’s Economic & Strategic Research (ESR) Group, over fifty percent of consumers surveyed weren’t sure what it is either. And, in cases like this, what they don’t know could hurt them – financially, that is. High DTI (not fico scores or the amount borrowers had in the bank) was the most notable reason to reject a loan applicant, as outlined by a 2014 FICO study of credit-risk managers covered by The Washington Post.
Debt to Income Ratio Why It Matters
Understanding Debt to Income Ratio (DTI)
Put simply, Debt to Income Ratio (DTI) is a calculation of your monthly debt payments divided by your gross monthly income.
Lenders calculate DTI in two ways, and both are important. First, they’ll add together all your expected housing expenses (the new mortgage, including taxes and insurance) and divide that by your gross (pre-tax) income. That’s called your front-end DTI.
Second, they do the exact same calculation but include your entire monthly expenses, like minimum payments on charge cards and auto loans. That’s called your back-end DTI.
For conventional mortgage loans (loans not insured by the government), mortgage companies are generally looking for 28 percent or lower for the front-end DTI, and 36 percent or lower for the back-end.
“Some lenders may be a little stricter, and others less so,” says Cara Pierce, who’s worked as a housing financial specialist with Atlanta-based ClearPoint Credit Counseling for 19 years.
Why Debt to Income Ratio (DTI) matters
Your DTI ratio is very important, Pierce says, because it’s what lenders use to figure out the amount of money they will loan you.
If you’re already using 10 % or even more of your gross income to pay for your monthly living expenses, such as car payments and credit card minimum payments, you’d have less than 26 percent for your other housing expenses to remain under 36-percent DTI on the back end.
A DTI greater than 36% doesn’t mean you won’t qualify. The fact is, Fannie Mae purchases loans from lenders with back-end DTI ratios as high as 45%. But you might want to re-evaluate just how much you would like to spend on a home – or if it’s even the proper time to buy.
Can I lower my Debt to Income Ratio (DTI)?
Lowering your DTI could help you obtain a lower interest rate “because less debt is generally considered a good thing,” notes Investopedia.
So if you still want that more expensive home, there’s two strategies to reduce your DTI.
First, pay down debt. Even paying a little over the minimum payment each month on accounts will assist. If you have a $100 monthly payment and can’t afford $200, just pay $125. That could make it faster for you to pay off the debt.
Alternatively, you could try to find strategies to you or your household to raise your income or consolidate your debt.
Either way, it’s important to know how lenders calculate DTI, and how a high DTI ratio could affect the chances of you being approved for a mortgage loan. “People don’t understand DTI because it’s a math equation,” says Pierce, “but it’s a number that lenders will use to approve or deny loan applications.”
You can calculate your Debt to Income Ratio (DTI) manually or make use of an online calculator. Consumers can request an absolutely free copy of their credit report annually at AnnualCreditReport.com or by calling 877-322-8228 FREE.
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$530,000-
Lot Size6,970 sqft
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Home Size3,008 sqft
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Beds5 Beds
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Baths3 Baths
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Year Built2013
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Days on Market1
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