Do you know what your debt-to-income ratio is? If the answer is no, don’t worry, you’re not alone. If the answer is yes, then learn even more about the importance of this number during your home-buying process. Zillow Porchlight has shared why understanding your debt-to-income ratio (DTI) is important when qualifying for a mortgage and how you can help lower it.
Put simply, 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 (your 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 same calculation but include all of your monthly expenses, like minimum payments on credit cards and auto loans. That’s called your back-end DTI.
For conventional mortgage loans (loans not insured by the government), mortgage lenders 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 Solutions for 19 years.
Why DTI matters
Your DTI ratio is important, Pierce says, because it’s what lenders use to determine how much money they will loan you.
If you’re already using 10 percent or more of your gross income to pay 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 stay under 36-percent DTI on the back end.
A DTI higher than 36 percent doesn’t mean you won’t qualify. In fact, Fannie Mae purchases loans from lenders with back-end DTI ratios as high as 45 percent. But you may want to re-evaluate how much you want to spend on a home — or if it’s even the right time to buy.
Can I lower my DTI?
Lowering your DTI could help you get a lower interest rate “because less debt is generally viewed as a good thing,” notes Investopedia.
So if you still want that more expensive home, there are two ways to lower your DTI.
First, pay down debt. Even paying a little over the minimum payment each month on accounts will help. “If you have a $100 a month payment and can’t afford $200, just pay $125,” advises Pierce. “That will make it faster for you to pay off the debt.”
Alternatively, you could look for ways for 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 your chances of being approved for a 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.”
[Read the full article: Here’s Why Your Debt-to-Income Ratio Matters]