February 28th, 2023 9:14 AM by Salim (Sam) Kader MLO# 130505
When you are shopping for a home mortgage - lenders would review the soundness of your loan application based on 5 Criterions. One of them is Debt-To-Income (DTI) ratio which is one of the most important numbers. It compares the minimum payments on all debt you must make each month with your gross monthly income. DTI tells a lender what percentage of your income is being consumed by debts. Lenders are evaluating your risk assessment associated with you taking another payment. The lower the DTI ratio is, the more confident the lender is in getting on time mortgage payments in the future based on the loan terms. Lower DTI also means that a borrower has excess income to cover unforeseen emergencies and to safe for a rainy day. As DTI ratios go higher, it signify poor credit management, living beyond your means and difficulty saving money for the future. You can also benefits from knowing your DTI because it can help you determine your budget, evaluate your current debt and whether you have enough income to take on a mortgage payment.
How to calculate DTI - A simple DTI calculation is to divide your total monthly obligations by your total monthly income to generate a percentage. However, not every monthly bill is included in your DTI. We will typically look at installment loan obligations such as auto and student loans as well as any revolving debt payments such as credit cards or a home equity line of credit. In short - if I were to pull your credit report today - everything that is reported under your name to the credit bureaus will be included in the numerator (total debt) as an aggregate of total minimum monthly payment of each debt. Alimony and child support payments are also included when calculating the DTI. However, utilities such as cable, phone bills, health insurance premium, and medical bills, auto insurance and life insurance payments, 401(k) contributions, are excluded. Any installment such as auto payment with less than 10 payments remaining are also not included. Your mortgage payments including principal, interest, taxes and insurance are contained in the DTI calculations.
What is a good DTI? As a general rule, the lower the DTI the better. Various loan programs have different DTI ratio requirements. If you have an excellent credit history, stable income and a down payment of 5% or more - most lenders will lend up to 45% DTI. Compensating factors such as larger down payment, higher reserve in the bank and an excellent credit history will be required for DTI between 45% to 50%. If you or your clients have a lot of revolving debt but also have plenty of cash in the bank - we will be able to make it work by paying off those revolving debts at closing.