Buying a new home can be extremely exciting, but the process of financing that purchase can feel overwhelming for many first-time homebuyers. In this edition of our continuing “All About” series, we’ll cover DTI ratios—a somewhat mysterious (but very important) part of your mortgage qualification and approval process.
What does DTI stand for, and what is a DTI ratio?
DTI stands for “debt-to-income”, so the DTI ratio is the amount of debt a buyer has, relative to the amount of money that they bring in each month as income. Lenders have DTI limit ratios that they use as a guideline, telling them how much a borrower can safely borrow to buy a home, while still successfully meeting their other financial obligations.
How do I figure out what my DTI is?
Borrowers can get a good idea of their DTI by using one of many online DTI calculators. (Credit.com has a good one here.) These calculators use your annual gross (pre-tax) income, divided by twelve, to estimate your monthly income. They then calculate what you spend each month on certain debts and expenses (typically housing costs, credit card payments, auto loan payments, student loan payments, etc.), and figure out what percentage of your monthly income is being spent on those obligations.
The resulting DTI ratio is expressed as two numbers divided by a forward slash, such as: 21/23.
Why are there two numbers?
There are two numbers because, in reality, the DTI ratio is calculating two different aspects of your monthly finances. The first number (known as the “front-end ratio”) expresses the percentage of your monthly income that goes solely towards housing costs. The second number (the “back-end ratio”) is the percentage of your monthly income that goes toward all of your debt obligations, including housing. The lower these numbers are, the more borrowing power you have.
I’ve calculated my DTI. Now how do I find out if it’s “good” or not?
Lenders vary in the DTI ratios they use, but there are some general rules of thumb. Conventional (30-year fixed rate) mortgages usually have DTI ratio limits of 28/36. FHA DTI limits are a bit more generous, setting a limit at 31/43. VA loans are limited at 41/41, and USDA loans (a popular product with many of our buyers), set a DTI limit of 29/41 for their borrowers.
While helpful, these limits are just a general gauge. Even if your DTI falls outside of these ranges, it is still worthwhile to talk with a lender about other financing products they offer that may fit your financial situation. Every buyer’s situation is unique, and there are many mortgage products that can get you into a new home in a fiscally sensitive and financially sane way.