Tons of people dislike math, but there is one easy calculation that is very necessary when purchasing a house. This is called the debt-to-income ratio.
Having a strong debt-to-income ratio can assist a person get approved. Having a weak debt-to-income ratio can be the key difference between approval and denial for a house loan.
The portion of calculating the ratio is rather simple. Understanding what is included, and what is not included in the calculation, requires a bit more work.
I’ll take out time to understand how this ratio works and what I can do to bolster my chances of getting approved for a house mortgage.
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How To Calculate Debt-to-Income Ratio
Here’s a simple two-step formula for calculating my DTI ratio.
- Add up all of my monthly debts. These payments may include:
- Monthly mortgage or rent payment.
- Minimum credit card payments.
- Auto, student or personal loan payments.
- Monthly alimony or child support payments.
- Any other debt payments that show on my credit report.
- Divide the sum of monthly debts by monthly gross income (the take-home pay before taxes and other monthly deductions).
- Transform the figure into a percentage and that is the DTI ratio.
Keep in mind the other monthly bills and financial obligations. Such as utilities, groceries, insurance premiums, healthcare expenses, daycare, etc. are not part of this formula calculation. My borrower isn’t surely going to factor these budget items into his decision on how much money to lend me. Keep in mind that just because I qualify for a $300,000 mortgage, that doesn’t indicate I can actually afford the monthly payment that comes with it when considering my entire budget.
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Why DTI Ratio Matters?
While there is no definite law establishing a definitive debt-to-income ratio that needs borrowers to take a loan, there are some generally accepted standards, especially as it regards federal home loans.
Let’s understand it from an example if I qualify for a VA loan, Department of Veteran Affairs guidelines recommend a maximum 41% debt-to-income ratio.FHA loans allow for a ratio of 43%. It is possible to get a VA or FHA loan with a greater ratio, but only when there are a few compensating factors.
The ratio required for conventional loans differs, depending on the borrowing institution. Most banks rely on the 43% fact for debt-to-income, but it could be as great as 50%, depending on factors like income and credit card debt. Bigger lenders, with big assets, are more likely to accept consumers with a greater income-to-debt ratio, but only if they have a personal relationship with the client or believe their income is enough to cover all debts.
Remember, evidence shows that the greater the ratio, the more likely the lender is going to have issues paying.
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According to you, what’s an ideal debt-to-income score?