Your Debt to Income Ratio (DTI Ratio) is used by mortgage lenders determine how much you can afford to borrow. Calculating your debt to income ratio is easy to do. Simply divide all of your monthly bills by your gross monthly income multiplied by 100 to get a percentage. Your debt to income ratio needs to fall within a certain range in order to qualify for a purchase or mortgage refinance loan.
What Is a Good Debt to Income Ratio?
DTI requirements vary by bank and lender; however, a healthy debt to income ratio falls with the range of forty to fifty percent. If your debt to income ratio is high you may still qualify for mortgage refinancing; however, your refinance rates could be higher than what lenders are advertising.
Here’s an example to illustrate how debt to income ratio is calculated:
Suppose your documented annual gross income is $120,00 from your pay stubs and your monthly bills total $4,000.
- Documented Annual Income: $120,000
- Monthly Bills: $4,000
- $4,000/$10,000 *100 = 40%
In this case your monthly income is $10,000 ($120,000 divided by 12 months in a year). Dividing your monthly liabilities from bills by your monthly income reveals a debt to income ratio of 40 percent. ($4,000/$10000 * 100 = 40%)
Mortgage lenders use an additional debt to income ratio known as your front end DTI which is calculated using your mortgage payment only. (Including taxes and insurance)
Front End & Back End Debt to Income Ratio
In our previous example if your mortgage payment is $2,000 of your monthly bill liability your front end DTI would be ($2,000/$10,000 * 100) 20 percent. Many mortgage lenders require both your front and back end DTI fall into a specific range in order to qualify. Most banks and lenders consider the back end debt to income ratio to be the most important as it gives a more complete snapshot of your finances.
Lenders that consider both front and back end will often list their requirements as 30/40. This is designated as front end DTI / back end DTI.
You can calculate your back end debt to income ratio by taking your average gross income from the last two years tax returns (add the total from these years divide by 2) and divide by 12. Then simply add up your total bills and divide by your monthly income. (Multiply this number by 12 to get the percentage)
Your credit report will show the figures lenders use for your bilks when calculating your back end debt to income ratio. You can use your debt to income ratio as the basis for deciding how much home you can afford when shopping for real estate.
Remember your debt to income ratio is only one indicator lenders use to gauge your ability to manage your debt. Your credit history and score also factor into the equation to determine what mortgage rates you’ll qualify. If the mortgage rates you’re being offered are coming in higher than what lenders are advertising the likely culprit is your credit score.
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