What is DTI and Why Does It Matter
If you have ever been through the home buying (or refinancing) process you have probably heard the term DTI being thrown around. DTI stands for Debt-to-Income. This is pretty straight-forward it is a calculation that lenders use as a part of the determination of whether or not to approve your mortgage application.
The calculation is exactly what is sounds it like, it is a ratio based on your monthly debts divided by your monthly income. There are a few aspects to this topic but if you remember anything from this post, I want it to be this: Understanding your DTI is important because it can directly impact whether you qualify for a home and how much you’re able to borrow.
To give you a quick example so that you can understand the basics of this concept, if you bring home $5,000 a month and you have $2,000 in monthly debt, then your DTI is 40%
When you are calculating your income its extremely important to understand in almost all cases, income that you claim is what is counted toward your gross monthly income. If you make $100,000 and you are self employed and you write off $70,000 then the annual income that is usable is $30,000. No matter how you make income, as long as there is a paper trail a Loan Officer will do their best qualify it and make it work. Some examples are: Salaried/hourly income, overtime (some nuances but essentially has to be consistent), self employed income (1099), freelance work, Social Security, pension, annuities, retirement distribution, rental income, dividends, interest income, Alimony/child support (if you want this to be used), Disability, and VA benefits …to name a few.
The key thing to income is that there has to be a history and it needs to be documented. Generally, cash only income (if its is unreported) will not count.
The next part of the equation is debts, just about everyone has debt. Some things to understand about debts, though, is to know what counts in the DTI equation. For the most part, this includes car payments, credit card payments, student loans, and anything that has a minimum payment that is reflected on your credit report. So you do not have to worry about your phone bill, electric, water, or groceries and things of the sort. A fun fact is for car payments and some similar payments if you have 10 or less payments left this will not count toward your debt, giving you more room. Another thing to consider, because not everyone pays just the minimums, the DTI will only take the minimum payment due; so if you have a credit card that you pay off every month for $1000, but the minimum payment is $29 then $29 is used toward your DTI.
So the next part that a Loan officer will go over with you, is there are two types of DTI:
Housing Ratio (front end)
Total DTI (back end)
Your housing ratio is also exactly what it sounds like. It is your (projected) mortgage payment, interest, taxes, and insurance. (AKA PITI “principal-interest-taxes-insurance) divided by your monthly income. so lets do an example:
PITI = $2200
Qualified Income = $8000
2200/8000 = 27.5%
Your Total DTI is now adding in those other debts we mentioned. So now counting the $250 of minimum credit card payments, $400 car payment and to make this a simple example we will only use those.
PITI + $250 + 400 = $2850
Qualified Income = $8000
2850/8000 = 35.63%
This means that 35.63% of your monthly income is used on debts.
So here is why this matters to you. You do not want to over-extend yourself and put yourself in a bad financial position. By keeping your DTI low you have the ability to budget properly and then with this knowledge you can make the best decision for you and your family.
To make sure that no one is put in a bad position there are safe guards in the sense that getting approved for a mortgage is dependent on your DTI numbers.
As a rule of thumb different programs have different DTI limits so generally
Conventional: 28% front-end 36% backend
FHA: 31% frontend 43% backend
There are other programs but to keep things simple for our basic understanding of DTI you can keep this in mind. This is exactly why two people that make $90,000 a year could have different homebuying power. If you are ever unsure where you stand, it always helps to speak to a licensed professional.