While you might not know what the Debt to Income Ratio (DTI) is or what its significance is, it is important to know it’s one of the major factors used by mortgage loan lenders in the Greater Boston Area to help them decide whether to accept or reject your loan application. By understanding how it is calculated, you can figure out your Debt to Income ratio prior to applying and find ways of reducing it, if your ratio is very high.
What Is The Debt To Income Ratio?
The total amount of your pay check which you must spend every month for prior debt obligations expressed in the percentage form is considered as the debt to income ratio.
Types of Debt To Income Ratios
There are two types of debt to income ratios which are used by lenders to help them decide on mortgage loan applications:
- First DTI (Also known as Front End Ratio): The first DTI takes into account only the amount the applicant will have to pay every month towards the house alone i.e. mortgage principal, mortgage insurance, mortgage premiums, property taxes etc.
- Second DTI (Also known as Back End Ratio): This second ratio takes into account all debt the applicant has to pay in a month’s time i.e. the amount owed in the first DTI along with other debts such as student loans, payments for credit card, car loan payments etc.
How to Calculate the DTI?
In order to find you debt to income ratio, do the following:
- Calculate Amount Owed: First, add up all the monthly payments you are currently making such as car loans, student loans, and credit card payments.
- Add In Mortgage Payments Expected: Using an online mortgage loan calculator, you can easily find out, roughly, the amount of money you will have to pay in monthly payments. Add this amount to the previously calculated debt (this will show total debt owed from your side).
- Divide & Multiply: Divide the total number you get by your gross monthly income (pre-tax income), then multiply that number by 100 to get it into percentile form.
E.g.: If your gross income every month is $6,000 and your monthly debt payments (inclusive of prior debt and projected monthly mortgage payments) are $2,000. Your monthly debt to income ratio will be (2000/6000)*100 = 33.3%.
Most lenders require a debt to income ratio of less than 36% for the second DTI and a ratio less than 28% for the first DTI, but these numbers increase a little if you apply for a FHA or VA mortgage loan. No matter what your debt to income ratio is currently, along with your credit scores and initial down payment, your debt to income ratio plays an important role in the mortgage loan process. So if your ratio is high, do you level best to lower it prior to applying for a loan. If it is low, try to make it lower since it increases your chances of approval, and at times allows for a smaller monthly interest payment.