DTI Reveals True Home Affordability
Credit scores often get the biggest headlines.
Your three-digit FICO score is a key factor for qualification and mortgage rates.
But there’s another number that does a better job at telling you what you can afford: your debt-to-income ratio, or DTI.
Your DTI is a comparison between your monthly payments and your income. A low DTI denotes you are buying a home well within your means.
Lenders want to see that you are taking on a sustainable housing payment. That’s good for you and them.
Knowing your DTI before you apply is by no means necessary, but it can help buyers form an educated estimate of their price range.
Many buyers will discover that homes in their area are very affordable as they look at their income, current payments, and future housing costs to determine their DTI.
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No Two Buyers’ Payments Are Alike
The lender never looks at the amount of debt independent of the applicant’s income.
A certain amount of payments can be too much for one consumer and no burden at all for another.
Think of it this way: $4,000 worth of monthly debt obligations are a real problem for consumers who earn a gross monthly income of just $6,000. But that same $4,000 of debt isn’t nearly as problematic for consumers who earn $18,000 a month.
Figuring your debt-to-income ratio isn’t difficult. Divide your recurring monthly debt obligations into your gross monthly income.
For instance, you would have a 25% DTI with an income of $10,000 and payments of $2,500.
While the formula is easy, it helps to think like a lender when you calculate your debt payments.
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Calculate Your DTI Like A Lender
Mortgage lenders are the final decision maker. It’s important to understand how they calculate DTI.
The lender will look at your recurring payments for anything financed, such as cars, student loans, and credit card purchases. If you have monthly child care or alimony payments, these also count as part of your recurring monthly debt.
They will not include non-debt monthly payments such as utility payments, cell phone bills, and gym memberships.
If you’re not sure which of your bills the lender will consider debt payments, obtain a free credit report. Consumers have access to a free report once per year from each of the three major bureaus, Transunion, Experian, and Equifax.
Go through the report and add the payment amounts listed. This is exactly how the lender will calculate your non-housing payment total.
Estimate All Parts Of Your Future Housing Cost
After calculating your non-housing debt, the lender will estimate your new monthly housing expenses.
Your future payment amount will consist of a number of pieces.
- Principal
- Interest
- Mortgage insurance, if any
- Property taxes
- Homeowner’s insurance
- Homeowner association (HOA) dues
You can determine your principal and interest payment with any mortgage calculator. Some even estimate your mortgage insurance cost. Property taxes can vary widely by region of the country. Search for home in your area and price range on a real estate website. Each listing should state the amount of taxes, which you can use for your estimate.
Homeowner’s insurance can be anywhere from $50 to $200 or more per month, but for the typical house and borrower, should be around $75.
HOA dues almost always apply when buying a condo, but often when buying a single-family home in some neighborhoods too. Search for homes in desired neighborhoods to check common HOA dues, if any.
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Use All Your Income
Most U.S. workers’ paychecks bear little resemblance to their actual income.
A large amount is removed for income taxes, Medicare, and Social Security taxes. In addition, many workers voluntarily contribute to a 401k plan and pay medical insurance premiums too.
The end result is take-home pay that is significantly less than gross income.
Fortunately, the lender will use all your income to calculate your DTI.
In addition, you can also include monthly rental income, any alimony payments you receive, pension income, disability income and many other payments you receive each month.
However, lenders may calculate these income types differently than you would. For instance, only 75 percent of your rental income “counts” toward qualifying income.
Likewise, self-employed income can be difficult to calculate on your own. The lender will deduct any write-offs from total business income.
The point is, be conservative when estimating non-salaried income. Lenders will provide an income analysis as part of the pre-approval process. If you are self-employed, this may be the only way to know your lender-calculated income.
Many Exceptions To The 43% DTI Rule
When applying for a mortgage loan, you want to aim for a debt-to-income ratio that is lower than 43 percent. That’s because 43 percent is the highest DTI many loan types can hit and still be considered a Qualified Mortgage.
A Qualified Mortgage is one that the Consumer Financial Protection Bureau considers sustainable by the buyer. The rule came out of the 2010 Dodd-Frank Act as an effort to protect consumers after the housing downturn of last decade.
But the forty-three-DTI rule is by no means hard-and-fast.
For instance, Fannie Mae’s new program, HomeReadyTM, allows a 50 percent DTI when non-borrower household members are contributing to homeownership costs.
Likewise, FHA loans and VA home loans which receive approvals are considered Qualified Mortgages despite their DTI.
Borrowers who do apply for a loan with a 43 percent cap have options if they are above the DTI limit.
They can target a lower-priced home, which would reduce their estimated new monthly mortgage payment and debt-to-income ratio.
Home buyers can also refinance their auto loan, or consolidate student loans and credit cards to reduce the monthly payment. The lender does not factor in loan balance, but only the minimum amount due each month. Reducing payments helps, even if loan balances don’t change.
Click to see today’s rates (Aug 15th, 2016)
Let Your Budget Make The Decision
The key is to get your debt-to-income ratio to a level that is not only attractive to lenders but is also comfortable for you. Your lender might approve you with a debt-to-income ratio of 40 percent, but you might not feel comfortable with monthly obligations that consume that much of your monthly income.
Your payment comfort level may be much lower than the housing expense the lender approves.
Before you apply for a mortgage, take the time to roughly calculate your debt-to-income ratio. This number will tell you plenty about how much of a monthly mortgage payment you can comfortably afford.
And don’t be afraid to be more conservative when it comes to your debt-to-income ratio. Enjoying homeownership starts with sustainable, comfortable costs.
What Are Today’s Mortgage Rates?
Low rates are decreasing the cost of homeownership. Falling rates help home buyers receive approvals, even if their applications were not accepted just a few months ago.
Get a rate quote for your upcoming home purchase. All rate quotes come with a home-buying eligibility check and access to your credit scores.
Click to see today’s rates (Aug 15th, 2016)
The information contained on The Mortgage Reports website is for informational purposes only and is not an advertisement for products offered by Full Beaker. The views and opinions expressed herein are those of the author and do not reflect the policy or position of Full Beaker, its officers, parent, or affiliates.
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