by Mark Fitzpatrick
Mortgage lending underwriting criteria falls into three general categories — credit, collateral, and capacity. Credit has to do with how well you pay your bills (as evidenced by a credit report and score), collateral has to do with the type and quality of the property you’re using to secure the loan, and capacity has to do with your financial ability to repay the loan. Your debt-to-income ratio falls into the latter category — capacity — and is considered an important factor in determining your financial ability to pay back your mortgage.
What is a Debt-to-Income Ratio?
Your debt-to-income ratio, or DTI, expresses in percentage form how much of your gross monthly income is spent on servicing liabilities such as auto loans, credit cards, mortgage payments (including homeowners insurance, property taxes, mortgage insurance, and HOA fees), rent, credit lines, etc.
Living expenses such as cable, gas, electricity, groceries, etc., are not considered part of your DTI.
If your DTI is high, it means you are highly leveraged and have tight finances, which, naturally, is considered risky from a lending standpoint. On the other hand, if your DTI is low, the lender knows you have plenty of room in your monthly budget to absorb unexpected expenses and still make your mortgage payments.
Both Fannie and FHA allow for higher DTIs under limited circumstances, but there are standard guidelines.
Calculating Your Debt-to-Income Ratio
If you’re in the market for a home loan, it doesn’t hurt to calculate your debt-to-income ratio ahead of time so you know where you stand. To do this, simply tally up your total monthly debt obligations and divide by your gross monthly income, as follows:
- Either obtain a recent copy of your credit report or gather up your most recent statements for all your debt obligations. Note that only debtobligations are included in your DTI, not utility bills, phone, cable, etc.
- Tally up your payments for all debts, including auto loans, credit cards (use just the minimum payment), credit lines, student loans, and any other debt obligations that you have. If you have an American Express credit card, use 5% of the outstanding balance if the minimum payment is showing as the full balance on your credit report. Note that underwriters will include any child support payments in your DTI.
- Add your rent or home mortgage payment, including monthly property taxes, homeowner’s insurance, homeowner’s association (HOA) fees, and private mortgage insurance (PMI) premiums.
- Divide your total debt obligation figure by your gross monthly income (assuming you’re a W2 wage earner), then multiply by 100 to get a percentage.
If you’re self-employed, I recommend working with your loan agent to determine your qualifying DTI. Self-employed income verification is more complicated and there’s really no way to determine your qualifying income definitively without tax returns.
Keep in mind that when you’re qualifying for a home loan, your qualifying DTI will be based on what your expenses will be after the loan is complete. In other words, if you’re currently renting and are taking on a house payment higher than what you’re paying for rent, your qualifying DTI will be based on the new mortgage payment. If you’re refinancing and consolidating debts, your qualifying DTI will reflect your expenses after the various debts are consolidated.
Any questions about calculating DTI? Any tips you’d add?
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