Debt-to-income (DTI) ratio is the percentage of an individual’s monthly gross income that goes toward paying debt such as credit cards, car payments, and student loans. Most importantly, this equation plays a key role in the mortgage qualification process. Here are a few details on exactly what DTI is, and what it has to do with obtaining a home loan.
What is debt-to-income ratio?
Most of the banks in this country use your debt-to-income (DTI) ratio to see if you’ll be approved for your mortgage loan. There are always exceptions to the rule but in general, the underwriters don’t want your DTI to be higher than 36% on the front end and 43% on the backend. To calculate your front end DTI ratio, simply divide your ongoing monthly debt payments by your monthly gross income. For revolving debt, such as a credit card, use the minimum monthly payment for this calculation. This might not match what you typically pay each month, but the minimum payment will be used when calculating DTI. For installment debt, which is money owed in fixed payments for a fixed number of months (such as installments on a washer/dryer or car payment)—use the current monthly payment. For example, if you’re paying $1,500 to debts and making $7,000 in gross (or pre-tax) income, dividing $1,500 by $7,000 will give you a DTI ratio of 21% percent. To figure the back end ratio simply add your monthly debt with the proposed monthly mortgage payment (which is made up of principal & interest, property taxes, homeowners insurance, PMI when applicable, and HOA when applicable) and then divide that by your monthly gross income. For this example let’s say your mortgage payment will be $1,400 – you’ll add that with the monthly debt of $1,500 for a total of $2,700. Divide this by the monthly gross income of $7,000 for a back end ratio of 41%.
Why does DTI ratio matter?
Your personal PERL lending specialist will use your DTI ratio to assess your ability to pay for a loan. The number should be low, because borrowers with a higher debt-to-income ratio are more likely to have an issue making monthly payments. Generally, your DTI ratio should not exceed 36 percent of your gross monthly income on the front end and 43% on the back end. A higher DTI ratio might mean you’ll pay a higher interest rate, or maybe even be denied a loan. To verify income, you’ll need the most recent 30 days of paycheck stubs and W-2 tax forms for the past two years. And, if you generate income from a source outside your primary job (such as part-time work or side jobs that pay only commission), you’ll have to provide W-2 forms for the last two years from that employer as well. In addition the loan officer you’re working with will want to pull your credit to see the debt that is being reported.
And as always, don’t hesitate to call your PERL loan officer if you have any questions at all!