A common question in the home buying process is how much can I get pre-approved for? The formula lenders use for qualification is called debt to income ratio, known as DTI which is your monthly debt divided by your gross income – income before taxes are taken out. There are two debt income ratios the front end and the back end; the first part being your housing expenses, mortgage payment, taxes, insurance, PMI and condo fee. Lenders want the front end ratio under 29% because you never want one liability too high in comparison to your income.
The second part is being your housing expenses plus your monthly obligation; these payments are expenses like minimum monthly credit card payments, student loan payments, alimony, child support, car payment, etc. Your lender will add up all your monthly installments and revolving debts in addition to your estimated monthly mortgage payments and housing expenses and divide that number by your monthly gross income. Lenders typically want the ratio under 41% though you can get approved slightly higher depending on compensating factors.
It is extremely important to remember you never want your total housing expenses and debts too high because that’s not always possible in the future to refinance or sometimes even to sell your home.
How does debt income ratio affect my lifestyle?
- If your back end ratio is over 41%, no vacations for you.
- If your back end ratio is under 35% about one vacation per year.
- If your debt to income ratio is less than 30%, two weeks of vacation.
- If your debt to income ratio is less than 20%, you probably have a really big house and have lots of vacations.