Mortgage Math: How Your Debt-to-Income Ratio Affects Your Financing
There are many factors a lender will consider when they are determining whether you qualify for a mortgage or not. They’ll look at your credit score, how stable your income is, and how often you pay your bills on time.
Another key factor which you should be aware of is your debt-to-income (DTI) ratio.
DTI Ratio Defined
Your DTI ratio is how much of the gross total of your monthly income is dedicated to recurring monthly debt payments, represented as a percentage. Generally speaking, the lower your DTI the better your chances are of getting approved for the loan.
For example, if you make $7,500 a month and you owe $1,500 a month in debt payments, you’d have a DTI ratio of 20% (you’d also be in pretty good shape, as 20% should be a solid enough figure for you to qualify for most mortgages and other loans, as long as your other ducks are in a row as well). Most recurring monthly debts, such as alimony/child support payments, mortgages, auto loans, student loans, and credit card payments will all be included in the calculation, just as most forms of income, including wages, pensions, social security, and child support/alimony received will be factored in as well.
Under certain circumstances, it is possible for some debts to be excluded from your DTI calculation. Additionally, it’s important to take into account that when a bank is reviewing your finances, they will include the projected payment of the loan they are considering giving you in their DTI ratio calculation.
Why Lenders Care
It’s in a lender’s best interest to only give loans to people who can afford to pay them back.
Income only tells half the story, as a person might be less financially stable than they seem if they have a lot of income but also a lot of expenses. By weighing your income against your regular debt payments, lenders get a more complete understanding of your financial situation.
The 43% Rule for Qualified Mortgages
The Consumer Financial Protection Bureau (CFPB) was formed as a response to the Great Recession of 2007 – 2009, which was caused in large part by reckless mortgage lending practices.
The CFPB has established Qualified Mortgages as a way to help homeowners remain financially stable. Many features of Qualified Mortgages are advantageous to borrowers, including:
- There are restrictions on how many fees you are charged
- There are also restrictions on how much of your income is allowed to go towards your mortgage
- Payments are not allowed to suddenly get much larger at the end of a loan term
- Loan terms cannot exceed 30 years
In order to be approved for a Qualified Mortgage and benefit from those features, you must have a DTI ratio of less than 43%.
If you have any questions about your DTI ratio or any other aspects of purchasing real estate, please do not hesitate to contact The Law Office of Ray Garcia today and let us guide you throughout the process!
Law Office of Ray Garcia, P.A.
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