Good credit, down payment AND my debt-to-income ratio??

October 25, 2013 — Leave a comment

chalkboard dtiYou’ve worked hard to protect your credit score, you’ve been diligent with your savings, and you’ve maintained a stable income.  Why is your lender bringing up your debt-to-income ratio?  What IS your debt-to-income ratio and how does it affect your qualifying power?

First, let’s establish what the debt-to-income ratio is, and then we’ll cover its application to mortgage qualifying.

Your debt-to-income ratio (DTI) is calculated by totaling your monthly debt (the debts reflected on your credit report such as auto loans, credit cards, mortgages, charge cards) + your proposed total monthly housing payment (mortgage + property taxes + home owner’s insurance + HOA dues, if applicable).  The total of these monthly payments are then divided into your gross, verifiable monthly income (more on this in a second).  The resulting figure equals your debt-to-income ratio.

For example:

John & Jane earn a combined $5,000 p/mo (gross, before taxes are taken out) and they have the following monthly payments:

$250 Auto loan

$300 Auto loan

$ 50 credit card

$ 35 credit card

$150 student loan

$785 total minimum monthly payments (remember this number….we’ll be using it in a minute)

John & Jane are looking at a $150,000 house.  Will they qualify based on their debt-to-income ratio?  Let’s look at their total estimated monthly housing payment.

$744 mortgage payment (I’m using a 30yr term with 5% down payment)

$338 property taxes

$ 88 home owner’s insurance

$ 86 mortgage insurance

$1256 total estimated housing payment

 

What is John & Jane’s debt-to-income ratio?

$ 785 total minimum monthly payments

$1256 total estimated housing payment

$2041 total monthly payments

Debt-to-income ratio = total monthly payments / gross monthly income

$2041 / $5000 = 40.8%

Effectively, in this example, John & Jane’s debt-to-income ratio = 41%.(rounded up)

Did I mention there are TWO debt-to-income ratios?? I know, I know, this is ‘head spinning’ stuff, I agree.  However, my goal is to ultra-prepare you, so please, walk with me here as I explain.

For conforming, conventional loans the preferred DTI is 28/36.

For FHA loans the preferred DTI is 31/43.

What does this mean?  Simply put, the first number represents the total estimated housing payment as a percentage of your gross monthly income and the second number represents your housing payment plus all other monthly payments (auto loans, credit cards, student loans, etc) as a percentage of your gross monthly income.

Let’s use John & Jane’s scenario from above.

$1256 is their estimated housing payment

$2041 is their total of all monthly payments, including their housing payment

$1256 / $5000 (income) = 25.1% (this is their ‘housing’ ratio)

$2041 / $5000 (income) = 40.8% (this is their ‘total’ ratio)

Therefore, in this scenario, their DTI is 25/41

What are some things that can affect your DTI?

  • Child support / wage garnishment
  • IRS payment plans (typically for income tax owed)
  • Loss of income reflected on previous year’s tax return (self-employment or partnerships)
  • Rental income loss reflected on tax returns
  • Co-signed loans

I hope this is helpful.

Are you curious how self-employed income is treated for qualifying?  Email me here cole@coleholmes.com for a FREE self-employment breakdown.

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