How Does the Debt-to-Income Ratio Work?

What Is My Debt-to-Income Ratio?A person's ratio of debt to income could play a significant part in the kind of mortgage loan they can get and the interest rate they may pay. Having too little income or too much debt affects buying power directly. With this guide, prospective home buyers will understand the ratio they may need to buy a home.

For informational purposes only. Always consult with a licensed mortgage professional before proceeding with any real estate transaction.

Debt-to-Income Basics

Ability to repay a mortgage is one of the most important factors in a person's application for the loan. This is determined through a number of aspects, but an applicant's debt-to-income (DTI) ratio is one of the easiest to calculate. When people input their income and debts into a calculator to figure out how much they might be able to get in a loan to buy a home, their DTI comes into play. Usually, lenders look at two forms of DTI, one that relates only to the mortgage payment, and one that factors in all debts. People may notice that their buying power is primarily capped by one or the other.

Front-End DTI

Lenders understand that a person who is weighed down with a large mortgage payment is less likely to be able to pay it back if something goes wrong. This is why they want home buyers to get a loan that is proportional to their gross income. As a general rule, people should aim to keep their mortgage payment to less than 28 percent of their income. The mortgage payment includes:

  • principal
  • interest
  • property taxes
  • insurance
  • homeowners association dues, if applicable

In some cases, buyers can get approved with a front-end DTI of 31 percent. Changes to mortgage interest rates can affect the size of the mortgage. People whose front-end DTI is close to the limit should shop around for the best rates.

Back-End DTI

During the application process, lenders also need to verify that buyers are not taking on too much debt, considering all their obligations. This is why they also calculate the back-end DTI, which counts all debts that applicants are expected to pay. The back-end DTI usually covers debts like student loans, car payments, and credit card debt. It may also include regular financial obligations such as child support or alimony.

Ideally, people would have a back-end DTI of 36 percent or less. However, many loan programs provide options for buyers with a back-end DTI of 45 percent or even 50 percent. Lenders have some flexibility in how they approach loans for people in special situations (e.g. a high cost-of-living area), but most will stick to these standards.

How Home Buyers Can Improve DTI

Since the maximum mortgage loan that borrowers can get is capped by the front-end or back-end DTI, buyers want to be sure that they have taken reasonable steps to minimize these ratios. People who have a lot of non-mortgage debt may wait to buy a home until they can pay down some of it.

Applicants who have income from a number of sources should investigate the different types of income that lenders will consider. If people can document their income through pay stubs, bank statements, or tax returns, it may qualify. Increasing the total valid income on the application naturally lowers DTI, which can help increase the possible mortgage amount.

Buying a home in Lorton starts with a basic calculation of a person's debt-to-income ratio. Buyers who know these ratios and how they work will be better prepared to apply for a mortgage.

For informational purposes only. Always consult with a licensed mortgage professional before proceeding with any real estate transaction.

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