Whether you are buying your first home or a secondary property, getting a mortgage stands out as the most popular way to purchase a home. In 2021 alone, a whopping 23.3 million aspiring homebuyers applied for a new mortgage in the United States.
If you have planned to join this group, you may have come across the debt-to-income ratio (DTI) as a paramount requirement for a mortgage. Simply put, DTI determines what percentage of your income goes towards your existing monthly debt payments.
Lenders use DTI to assess your ability to repay your mortgage and manage your monthly payments for your home loan. While the DTI limit varies across lenders, its status remains of equal importance across the board. Your mortgage can only get approved if your DTI matches your lender’s preferred limit.
To help you understand how this works, here is what’s used to calculate your DTI ratio.
How is DTI Calculated for a Mortgage?
DTI is calculated for a mortgage by adding up your existing monthly debts and then dividing them by your monthly gross income.
These debts are segmented into two sections: front-end ratio and back-end ratio.
Front-End Ratio
The type of debts that are assessed within this group is related to your mortgage and ongoing homeowner responsibilities. These include but are not limited to the following obligations.
- Mortgage payments
- Property taxes
- HOA dues
- Homeowners Insurance
- Other insurance that is tied to your home
Front-end ratio is also known as housing ratio.
Back-End Ratio
The type of debts that are calculated under the back-end ratio include but are not limited to:
- Credit cards
- Student loans
- Car loans
- Personal loans
This means that the debt-to-income ratio looks at the payments you make to your lenders for rollover debts, such as credit cards, as well as ongoing debts, such as student loans.
While DTI does not factor in your spending for groceries, utility bills, and personal insurance, it does include possible home loan debt expenses, such as monthly mortgage payments and property taxes.
This means that you can have an idea for your back-end ratio from the get-go. But the front-end ratio is determined by your lender and updated figures that pertain to the home you choose.
What is Used to Calculate DTI for a Mortgage?
In order to calculate DTI, you can use the following steps:
- Add up your existing debts. This would be your back-end ratio, which includes existing monthly debts to other lenders.
- Divide it by your monthly income. This would include your total gross income, without any deductions for taxes, groceries, or front-end ratio.
- Convert the resulting figure into a percentage. Usually, when you perform the above steps, you get a number with a fractional part. You need to turn this fractional part into a percentage to get your DTI.
For example:
- Your monthly debt expenses for the back-end ratio are $2,375.
- Your monthly gross income is $10,500.
- You divide 2,375 by 10,500, which sets out to be 0.226.
- You turn the fractional part into a percentage, which results in 22.6%.
By using this method, you can calculate your debt-to-income ratio for your back-end ratio. Your lender can then add the front-end ratio after assessing your projected expenses with your mortgage.
What is the Typical DTI Limit for a Mortgage?
Typically, lenders want your DTI to be 36% or less for the back-end ratio and no more than 28% for the front-end ratio. Popular mortgage lenders such as Fannie Mae and Freddie Mac accept DTI ratios as high as 50%.
However, the actual acceptable range for this debt calculation ratio depends on your lender. Some may accept higher ratios, while others may draw the line on lower limits.
What is Credit Impact and Credit Utilization?
During your search for mortgages, you may have also seen terms such as credit impact and credit utilization. Credit impact refers to any actions that influence your credit scores, while credit utilization points to how much funds you have used up from your approved credit.
For instance, if you have a total credit limit of $20,000 and a current balance of $2,000, you will have a 10% credit utilization score. This is an astonishing number and well below the max to get a mortgage, which is usually around 30%.
Ready to Become a Homeowner? Contact First Centennial Mortgage Today
At First Centennial Mortgage, we specialize in offering mortgages at competitive rates. Whether you have further questions about DTI or simply want to start the process of becoming a homeowner, don’t hesitate to contact us today. We will be pleased to discuss your requirements and guide you through the process. Contact us today.