Understanding Your Debt-To-Income Ratio and Why It Matters
Your debt-to-income ratio can make or break your home loan application.
If you’re a little unsure what DTI ratio is, you’re not alone. According to Fannie Mae’s Economic & Strategic Research Group, over half of surveyed consumers didn’t know what it is either.
But, not knowing about DTI can hurt you financially when it comes time to apply for a home loan.
High debt-to-income ratios are the top reason lenders reject a loan applicant, according a study covered by The Washington Post.
DTI is simply this- a calculation of your monthly debt payments divided by your gross monthly income.
There are two different ways that DTI is calculated.
Back-end DTI is calculated by adding all of your monthly expenses and subtracting that from your gross monthly income.
However, home loan lenders also want to know your front-end DTI; calculated by adding all your expected housing expenses and dividing that by your gross income.
For the most part lenders want to see a 28% or lower front-end DTI and 36% or lower back-end DTI.
Your DTI ratio helps lenders determine how much they will safely be able to loan you.
If you aren’t living within your means this puts greater risk on your lender. However, if you have good DTI ratios this shows lenders that you have enough money to cover your current and expected expenses that come with home ownership.
These ratios can make or break your chances of snagging your dream home. So, if you want the best chance of getting that perfect home there are two ways to lower your DTI ratios.
- Pay down your debt. Even paying a little over the minimum payment each month will help.
- Raise your income. Set a goal to get that raise at work or take on a second job.
It’s good to know how important DTI ratios are and equally as important for you to work towards lowering your ratios. Doing so will help guarantee the loan you need.