What is debt-to-income (DTI) in mortgage?

DTI measures how much of your income goes toward debt payments. Lenders use this ratio to assess your financial stability and determine your ability to handle a new mortgage. 

In the mortgage world, a lower DTI gives you a stronger loan application because it means you have more room in your budget for a mortgage payment. So, if your DTI is high, it might be worth looking at ways to pay down debt or increase your income before you apply for that home loan.

What is considered a good DTI ratio?

A good debt-to-income (DTI) ratio is typically one that aligns with mortgage lender requirements. For FHA loans, a DTI ratio of 43% to 50% is generally a golden ticket, meaning up to 50% of your monthly income can go toward debt payments, including the mortgage. Conventional loans usually have a stricter cap, with a maximum DTI ratio of 43%. 

Any DTI under 36% is considered excellent. The typical DTI on a conventional loan is around 37% and for an FHA loan, the typical DTI is about 44%.

Do lenders include your mortgage payment in your DTI calculation when you apply for a loan, or is it just your existing debt payments?

When you’re applying for a mortgage, lenders don’t just look at your existing debt—they factor in the new mortgage payment too. This inclusion impacts how lenders gauge your ability to handle the new loan.

How do lenders calculate DTI?

1. Add up all your current monthly debt payments.
2. Include the estimated new mortgage payment (covering principal, interest, taxes, and insurance).
3. Divide this total by your gross monthly income.

Let’s say you make $75,000 a year, which translates to a gross monthly income of $6,250.

• At 50% DTI:
  50% of your gross monthly income would be $3,125. This means that if you’re applying for an FHA loan, you could potentially allocate up to $3,125 each month toward all your debt payments, including the mortgage. So if your debt payments are $1,125 a month, you would have $2,000 remaining for your mortgage to stay under the 50% DTI threshold.
• At 43% DTI:
  43% of your gross monthly income would be $2,687.50. For a conventional loan, this is the maximum amount you should ideally spend on debt payments, including the mortgage, to stay within lender guidelines. So if your debt payments are $687.50 per month, you would have $2,000 to spend on your monthly mortgage payments to stay under the 43% threshold. 

Are there different types of DTI?

Lenders assess two types of DTI ratios for mortgage applications:

• Front-end DTI: This focuses solely on housing-related costs. It includes the new mortgage payment, property taxes, insurance, and any homeowners association fees.
• Back-end DTI: This is the broader ratio that takes into account all your monthly debts, including the new mortgage payment, alongside your current debts like car loans, student loans, and credit card bills. It’s the more common measure used to determine mortgage qualification, giving a comprehensive view of your financial landscape

What types of debt are included in the DTI ratio calculation?

• Credit card payments: Monthly minimum payments on credit card balances.
• Student loans: Monthly payments for student loans, whether they are federal or private.
• Car loans: Monthly payments for auto loans or leases.
• Personal loans: Monthly payments for personal loans, including payday loans.
• Mortgage payments: For DTI calculations, this includes the total of your current mortgage payment or the projected new mortgage payment if you’re applying for a new loan. This covers principal, interest, property taxes, and homeowners insurance.
• Homeowners association (HOA) fees: Regular fees paid to a homeowners association if applicable.
• Alimony and child support: Monthly payments for alimony or child support, if they are legally required.
• Other debts: Any other recurring debt payments, such as medical bills or installment loans.

How can I improve my DTI ratio before applying for a mortgage?

1. Pay down existing debts: Slash those credit card balances and tackle any personal loans. Reducing your debt load lowers your monthly payments, making your DTI ratio more attractive to lenders.
2. Increase your income: Whether it’s a side hustle or asking for a raise, boosting your monthly income helps improve your DTI. More income means you have a larger buffer when it comes to debt payments.
3. Avoid new debt: Steer clear of taking on new loans or credit lines before applying for a mortgage. The more you add to your debt pile, the harder it is to improve your DTI.
4. Check your budget: Tighten up your spending. Cut out unnecessary expenses and redirect those funds toward paying down debt.
5. Refinance high interest rates: If you have high-interest debts, refinancing them to a lower rate can reduce your monthly payments and help improve your DTI.
6. Make extra payments: If possible, make extra payments on your existing debts. This can reduce your principal balance faster, lowering your monthly obligations.
7. Consolidate debts: Consolidating multiple debts into one loan with a lower interest rate can simplify payments and reduce your monthly debt load.

How often do lenders reassess my DTI ratio during the mortgage application process?

Lenders are continuously calculating your DTI ratio to ensure you’re not overextending yourself and to protect you from potential financial strain. Here’s the lowdown:

1. Initial assessment: When you first apply, your DTI ratio is closely examined to get a snapshot of your financial stability and make sure you’re not taking on more than you can handle.
2. Pre approval stage: During pre approval, lenders dive deeper into your financials, including your DTI. This step is crucial for confirming you have a manageable level of debt compared to your income, ensuring you’re set up for success rather than facing financial hardship.
3. Final review: Before you get the final go-ahead, your DTI ratio undergoes a last check. This is to make sure that nothing has changed significantly in your financial situation that could jeopardize your ability to meet mortgage payments.
4. Post approval checks: If there’s a delay between approval and closing, lenders may reassess your DTI to ensure your financial situation remains stable and you’re still in a good position to handle the new mortgage.

Essentially, this ongoing DTI evaluation is all about protecting you from taking on a loan that could stretch your finances too thin. By keeping your DTI in check, lenders aim to safeguard your financial well-being and ensure you’re on solid ground as a homeowner.

Can I still qualify for a mortgage if my DTI ratio is above the recommended limit?

Absolutely, you might still snag a mortgage even if your DTI ratio is above the recommended limits, but expect some extra hoops to jump through. Lenders can be flexible, especially if you bring other strong assets to the table, like a stellar credit score, hefty savings, or a sizable down payment. These can help balance out a higher DTI.

Certain loan types, such as FHA loans, might be more forgiving about DTI, so they could still be on the table if your overall financial picture looks solid. Just be ready to show some compensating factors, like a high and steady income, a significant cash cushion, or a solid track record with existing debts.

Keep in mind, though, that a higher DTI might lead to steeper interest rates or less favorable terms, as lenders might adjust to cover the added risk. You might also need to provide extra documentation or face a more rigorous underwriting process to prove you can handle the new mortgage payments along with your existing debt. So while a high DTI can be a bump in the road, it’s not an automatic no-go. Chat with lenders about your specific situation to see what options are still within reach: 737-510-2523

If you’re ready to start your journey to homeownership, get pre approved with Tomo Mortgage today.