As you’re getting ready to purchase your first home, you may have encountered the word mortgage often. This is part of the process of buying a home especially if you’re not paying for it in full or in cash.
A mortgage is a specific type of loan that financial institutions offer to make home ownership possible, despite the buyer not paying the full amount of the property’s purchase price. Since the aforementioned financial institutions technically shell out most of the purchase price, mortgage applicants are subjected to a series of screening processes to ensure that they have the means to pay off the loan. An important factor that mortgage lenders pay attention to is the applicant’s debt-to-income ratio, or simply known as DTI.
What Is Debt-to-Income Ratio?
A DTI ratio shows a correlation between your existing obligations (debts) versus your receivables (income) and is usually monthly. It is computed by adding all the payments you make to settle your debts, then adding all your income. Divide your total monthly debt payments by your total income and you will have your DTI.
Therefore, when you apply for a mortgage, you can expect your lender to ask you to disclose all debts, such as student loans, car loans, credit cards, and others. They will ask you the same for your income, including any W-2 income and 1099 income as it is noted on your taxes. Make sure to be truthful when you disclose, this pertinent information as these lenders can verify this information using your tax returns and credit report.
What if you’re married? How does it affect your DTI?
If you are applying for a mortgage with your spouse, your lender will determine your DTI as a couple (and not individually). Thus, your lender will include all debts and all income that you both have listed. This includes your debts and incomes, whether it is individually contracted or shared.
On the other hand, if you applied for a mortgage without including your spouse’s name on the application, then the mortgage lenders will just look at the debt and income under your name. However, you have to take note that even if your spouse’s name is not included, he or she might still be listed as responsible for a spouse’s debt. With this in mind, it is best to disclose all debt that could be included in your monthly expenses to your spouse, so that there’ll be a complete air of transparency between you two.
How do you boost your DTI?
The exact DTI ratio that you need to reach depends entirely on the mortgage lender. On average, mortgage lenders may consider approving your mortgage application if your DTI ratio is 43% or less. So, to help you get a clearer picture of how this is determined, let’s look at the following examples:
Q: A pays the following debts: college loan ($500), car loan ($500), and credit cards ($1000). His gross monthly income is $6000. What is A’s DTI?
A: You add up all of A’s monthly debt payments: ($500 + $500 + $1000) and that’ll yield a total of $2000. Then divide that by $6000 (his gross monthly income). The answer will be in decimals so multiply that by 100 to get the percentage. What is the answer?
It is 33.33%. This is A’s DTI ratio. Is this a healthy ratio? Yes, generally. However, that ultimately depends on the mortgage lender.
Let’s say you’re not as fortunate as A and your DTI is in the 50s. What should you do? Going back to the same example. Let’s say your monthly income is just $4000.
Total Debt Payments: $2000, Gross Monthly Income: $4000, thus DTI is exactly 50%.
It can be gleaned from the example that to lower your DTI, you have to either lower your debt or increase your income. If you’re planning to pay off your debts first, it is practical to pay off debts that have a high monthly payment and those that have high-interest rates such as personal loans, credit cards, and car loans. However, if you’ve reached a point where you have already trimmed down your expenses to the bare minimum, then you might be better off looking for an extra income stream. If you are looking for a loan in Colorado Springs, reach out and let us help you today!