Debt-to-income ratio is one of the main key elements lenders use to determine the creditworthiness of a borrower. The ratio compares your debt burden to the size of your monthly payments. In addition to other financial records, lenders use this ration to determine whether or not they will grant you a loan.
How To Calculate Debt-to-Income Ratio
Your debt-to-income ratio is the percentage of your overall monthly income that you have that goes towards debt. You calculate this ratio by adding all of your monthly debt payments and dividing those monthly payments by your gross monthly income. Moreover, that amount is what you earn prior to taxes being taken out.
Keeping your debt-to-income ratio under 36% is a very wise thing to do. Moreover, this will increase the probability of you getting a loan.
For instance, if you are paying $1700 a month on your mortgage, $300 a month on your auto loan, and $400 per month on your additional debts, your monthly debt payments amount to $2000. If you have a gross monthly income of $8000, your debt-to-income ratio is 30%. $2400 is 30% if $8000.
On the contrary, if you have a gross monthly income of $8000 and have to pay $4000 in monthly debt, your debt-to-income ratio is 50%. Most people in this scenario are considered house poor because they are living well beyond their means since most of their income is going towards housing expenses.
At times, lenders also apply a subcategory of the DTI ratio which is the front-end ratio (housing ratio). This type of ratio shows the specific amount of your income that goes toward your housing expenses. This includes your real estate taxes, your monthly mortgage payment, and your association dues. In order to calculate the front-end ratio, you have to add up your expecting housing expenses and divide that number by your monthly gross income.
Mortgages: What's The Maximum Of Debt-to-Income Ratio?
What’s the Ideal Debt-to-Income Ratio for Mortgages?
If an individual wants to qualify for a good mortgage loan, his debt-to-income ratio can’t be any more than 43%. Lenders consider qualifying mortgages as home loans that have features that solidifies that buyers can pay their loan back. For instance, lenders don’t apply excessive fees to qualifying mortgages. Moreover, qualified mortgages also help prevent borrowers from negative loan products such as bad amortizing loans, which can lead them to financial hardship.
Lenders desire to grant loans to borrowers that have low debt-to-income ratios. A ratio higher than 43% sends a red flag to the lender. From the lender’s perspective, an individual with a high debt-to-income ratio can’t afford to have any additional debt. Moreover, if the borrowers fail to pay back the loan, the lender will lose money.
The Ideal Debt-to-Income for Mortgages
Even though 43% is the maximum amount of debt-to-income ratio that homebuyers can possess, they can benefit well from having a lower ratio. 36% or lower is the ideal debt-to-income ratio that lenders like to see in emerging homeowners.
Overall, you’ll be in the position to receive the loan amount you desire with a low debt-to-income ratio. You’ll qualify for lower mortgage rates as well.
If Your DTI is High, Don’t Apply Yet
If your DTI is 50% or more, it wise not to apply for a home loan.
Don’t be ashamed of having to wait an additional year to purchase your first home. We recommend for you to get your financial house in order and improve your credit score and history before applying.
Moreover, using a mortgage calculator before seeing a lender will let you know what type of house you can afford having. Don’t forget that the lower your DTI is, the less risky you are to lenders. You will be more whole regarding your finances as well.
Some Loans Don’t Require DTI
Typically, most lenders use the DTI (debt-to-income) ration to determine whether or not homes are affordable for U.S. homebuyers. Lenders also have to verify your income debts in order to move forward with the process. On the contrary, there are many high-mortgage programs that totally disregard the DTI calculation.
Streamline finances is available with the FHA, VA, and Fannie Mae & Freddie Mac.
The FHA Streamline Refinance
This type of streamline refinance option totally disregards the DTI requirements that are current for an FHA purchase loan.
Furthermore, the FHA rules for an agency’s streamline refinance program refrain the income verification and credit scoring requirements as part of the approval process. Instead, the FHA examines whether or not a homeowner has been making his payments on time with no problems.
The FHA determines whether or not a homebuyer can pay the bill if he can present forth a perfect payment history dating back to at least 3 months. In other words, you DTI have no play in regards to the FHA Streamline Refinance process.
The VA Interest Rate Reduction Refinance Loan (IRRRL)
This is another program that waives the DTI requirements so you don’t have to worry about it. IRRRL and FHA Streamline Refinance are similar to one another. According to the IRRRL rules, they want homebuyers to have a strong payment history in regards to paying their mortgage. They want to view your paystubs and W-2s to verify this information.
The VA Streamline Refinance is available for borrowers who are in the military that can prove they can benefit from the refinance in either in the form of a monthly payment that’s lower or from a change in the adjustable rate mortgage to a fixed rate loan.
The Home Affordable Refinance Program (HARP)
HARP is another type of refinance programs that disregards the DTI calculation. Moreover, Fannie Mae and Freddie Mac allow homeowners to replace “money in the bank” for verifying income under HARP 2.0.
The HARP 2.0 rules state that lenders aren’t required to collect your tax returns nor your pay stubs if you are a homeowner that can prove that you have a minimum of 12 months in PITI in reserve, in addition to having a perfect mortgage payment history of the last 6 months and 11 of the last 12 months.
Keep in mind that lenders do have the right to verify your income by using HARP; some even make the choice to do it.
Overall, remember that the more debt you have, the higher your ratio will be. If your ratio is too high, the more at risk you are from a financial perspective. To continue the course that leads to financial freedom, you have the power to calculate the DTI ratio each quarter to ensure that you are going in the right direction.
Furthermore, you need to go in a different direction if your DTI ratio shows that you are struggling financially.