debt to income ratio

What is Debt to Income Ratio?

When buying a home, there are a lot of different terms you need to get familiar with to truly understand the mortgage process. The debt to income ratio, or DTI, is a common term that deals with your ability to get a home loan. The debt to income ratio is one of the main ways lenders asses you ability to manage monthly payments and repay debts.

What is Debt to Income Ratio?

What does debt to income ratio mean?

Debt to income ratio is calculated by dividing all of your monthly liabilities by your gross income. This results in a percentage and must fall under a certain number in order to qualify for a mortgage. The maximum DTI varies among lenders but generally falls between 40-50%. For example, say your gross annual income is $60,000. This means your monthly income is $5,000. Say you have $2,000 a month in liabilities. This means your debt to income ratio is 40%.

Front end and back end Debt to Income Ratios

There are actually two debt to income ratios: the front end and back end ratio. The front end covers your proposed housing payment, while the back end covers all remaining monthly debts. In the example above, if your proposed housing payment is $1,200 a month, your front end ratio would be 24%, while you back end ratio would be 40%. While both are important to the lender, the back end ratio has a higher weight since it considers all your monthly debt, and therefore is more representative of the risk you present as a buyer.

What are the rule of thumb percentages for Conventions Loans?

This differs depending on what type of loan you choose. With a conforming loan, a safe rule of thumb would be 28/36. This means your front end debt to income ratio shouldn’t exceed 28% and your back end debt to income ratio shouldn’t exceed 36%. With an FHA loan, a safe DTI would be 31/43. With a VA loan, a safe DTI would be 41%. With a USDA loan a good rule of thumb is 29/41. It’s important to talk with your lender on their standards as every lender is different. If you are a good borrower otherwise, you’ll have a higher chance of being able to shift a little higher, since these numbers are conservative ratios. As with the entire mortgage process, if you are a good borrower, you are able to have a weak point. However, if you have bad credit, nothing in your savings accounts, and a variant DTI ratio, your lender and underwriter will have a harder time being confident that you are able to manage monthly payments.

You may also like: What is a Letter of Explanation?

1 reply

Trackbacks & Pingbacks

  1. […] You may also like: What is Debt to Income Ratio? […]

Comments are closed.