During the homebuying process, you’ll come across many terms, such as debt-to-income (DTI) ratio. This ratio allows your lender to see the balance you have between your income and your debts. You need to understand your DTI ratio, so you can be in the best financial standing before applying for a loan.
Simply put, the DTI ratio measures your ability to manage the monthly payments on your mortgage. This is done by taking all your debt payments (car, student loans, mortgage) and dividing them by your gross monthly income. Your gross monthly income is the amount of money you make before taxes and other deductions.
Every month you pay your mortgage ($1,400), car ($150), and student loans ($250). Your total monthly debt is $2,100 ($1,400 + $150 + $250 = $2,100). Your gross monthly income is $6,500, making your debt-to-income ratio .32 or 32% percent ($2,100 ÷ $6,500 = 32%).
So why is this ratio so important? When applying for a mortgage, your lender needs to ensure you will be able to handle your monthly mortgage payment. Your DTI is the percentage of your income that will be covering your mortgage payments. Don’t rely on your DTI when setting a budget, as it does not account for all costs of living. You will need to still consider your additional expenses, such as food and utilities.
If your ratio is too high, you might not qualify for certain programs. Most lenders have a set ratio they look for, typically less than 36%. The higher your DTI is the tighter your finances will be. Your lender wants to ensure you are able to live comfortably and can easily cover all of your debts and costs of living. Don’t worry, if your DTI is higher than 36% you can still qualify for a loan.
Before applying for a loan, you should calculate your DTI. If you find your ratio to be on the higher side, you can take some steps to lower it. Pay off as much of your debt as possible before applying. You should also avoid making any large purchases or obtaining any additional debt. If possible, you can also look for ways to increase your monthly income.
Becoming a homeowner requires a lot of preparation, especially financial. To increase the likeliness of obtaining the loan you want, calculate your DTI and adjust as needed.
If you are looking to purchase a home, you may have wondered what is needed to qualify for a mortgage. When your lender is determining whether you qualify for a home loan, many factors you may not have considered may come into play. Here are a few mortgage do’s and don’ts to keep in mind during your home buying process.
Don’t: Change jobs (without notifying your lender) – Changing jobs at any point during the home buying process can be risky. Changes to your income can make it more difficult for you to qualify for a loan. A new job may mean a change in pay structure; for example, you may go from a salaried position to something less stable, such as a commission-based job. But even if your pay structure remains the same, your lender may not be able to vouch for your ability to repay a home loan if you cannot show consistent income history.
Do: Have all your required documentation in place – If you do plan on changing jobs, notify your lender ahead of time. They will able to provide you with advice and let you know what documentation will be required. Be prepared to document as much of your previous income as possible, and make sure you can provide pay stubs from your new position.
Don’t: Apply for new credit cards – Your credit score is an important factor that your lender will consider when qualifying you for a mortgage loan. Applying for a credit card can affect your credit score, especially if you frequently open and close credit accounts.
Do: Reduce your debts – Your debt-to-income ratio (DTI) is another factor your lender will consider when qualifying you for a mortgage loan. Your DTI refers to your monthly obligation on long term debts divided by your gross monthly income. The less consumer debt you have to make payments on each month, the less risky you may appear to a lender, and the more likely it is that you may be able to qualify for a home. Pay off and consolidate as much of your consumer debt (credit cards, student loans, auto loans, etc.) as you can prior to applying for a home loan.
Don’t: Make any major purchases – It may be tempting to go out and spend a lot of money on furniture and appliances for your new place, but it’s important to wait until you close on your mortgage loan. You will want to keep your credit cards paid off, or at least to keep your balances low, to avoid negative effects on your credit score. You will also want to avoid deferred payment plans; even if payments aren’t due for months, it can still affect your DTI and your credit score.
Do:Pay your bills on time – For any outstanding debt or bills you may have, make sure you are making your payments on time. Late payments can show up on your credit report and affect your credit score.