Besides your credit score, your DTI (Debt-to-income) ratio plays a significant role in obtaining a new mortgage loan. It's actually one of the most crucial aspects of the mortgage loan process, as it helps underwriters determine if you have enough income available to take on a new mortgage payment. If your DTI is too high, you'll most likely be turned down by underwriting, so it's important to have a conversation with the loan officer (before you apply) about what the DTI expectations are underwriting has.
Factors that make up debt-to-income ratio:
DTI ratios are of two types which are used by mortgage lenders, namely back-end and front-end DTI.
· For W2 employees monthly gross income is used by front-end ratio to determine the percentage to go towards housing costs, including property taxes, monthly mortgage payments, homeowner’s association fees, mortgage insurance and homeowner’s insurance.
· The income calculated against of debt liabilities is determined by back-end ratio. It includes car payments, credit card debt, student loans, child support, other debt amounts and monthly mortgage payments, showing up on credit report. A knowledgable loan officer will be able to explain this in further detail.
Debt-to-income ratio calculation:
Back-end DTI ratio determination is possible by including all recurring total monthly debt payments like credit cards payments, child support, car payments, student loans etc. The final number is to be divided by gross monthly income. Those unsure about gross monthly income should know that this amount is one that is earned every month prior to deductions and taxes on a paycheck. Also, mortgage lenders prefer to just use base income but will also consider bonus and/or commission income. For bonus and commission income, you have to show it's been steady or increasing for the last two.
The amount used to meet living expenses (such as grocery expenses, car insurance, and entertainment expenses) is not included in the DTI ratio and is not present in your credit report.
The ideal debt-to-income ratio:
The ideal DTI ratio is to be under 42% for the back-end ratio. Depending on your credit score, liquid assets, and the size of your down payment amount, higher ratios are accepted by lenders, depending on the loan type applied for. When you have a low DTI you have a good balance between income and debt. By maintaining a good balance, you'll have a better opportunity to obtain your desired loan amount. Also, a lower DTI can mean the difference between an approval and a denial. Sometimes, a persona with a lower DTI will obtain better terms and conditions. To estimate the amount you can afford based upon your monthly expenses and income, contact a trusted loan officer to help you review your options.
How to reduce debt-to-income ratio?
Your DTI ratio can be reduced in two ways. One will be to pay off debt which will reduce your monthly payment obligations. The other way to reduce your DTI ratio will be to increase your gross monthly income. If you can't find a new full time job with higher pay then look for freelancing work or a second job.
