You’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.
According To Cole 