Unpacking This Vital Number
When you’re looking to buy your first house, it can be difficult to determine just how much home you can really afford. But by calculating and breaking down your debt-to-income (DTI) ratio, you can get a decent idea of your general price range. Underwriters actually review two different DTI ratios to determine if your monthly income is sufficient enough to cover the responsibility of a mortgage, according to the particular lender/mortgage program guidelines. By understanding how the ratio works and what it means, you can come to grips with one of the most important factors for getting approved for your loan. It might seem a bit confusing, but don't worry even if you aren't a math wizard, you can do it. And we are here to show you how...
First, there’s your front-end, or housing, ratio, which shows what percentage of your income would go to your housing expenses. To find this, your first step is to calculate your gross monthly income. Add up every penny you earn monthly before taxes and other deductions are taken out. Then take the estimated monthly mortgage payment and divide it by your gross monthly income. After you convert this number to a percentage, you can see what chunk those mortgage payments will take out of your gross income each month.
Most lenders prefer your front-end ratio to be around 28–31 percent. If you’re trying to calculate the maximum you can reasonably afford to spend on a mortgage with your current income (according to the lender), you can simply multiply your gross income by 0.31 and come up with a rough figure. So if your gross income is $5,000, you multiply that by 0.31 and come up with $1,550 — your monthly principal, interest, taxes, and insurance can’t exceed this number.
Then there’s the back-end, or total, ratio, which shows the percentage of your income needed to cover all your recurring debt obligations. To find this number, add up your estimated house payment and the entirety of your monthly debt expenses — the required minimum payments for every one of your loans — then divide it by your gross income. Ideally, this should be 43 percent or less, so you can use the same strategy as above to calculate your upper limit.
Of course, there’s always room for interpretation of these guidelines. Make sure to review your personal income and employment scenario in detail with a trusted mortgage professional to ensure everything adds up. Feel free to give Tim Hart a call at 239-437-4278, and he’ll guide you through the process.