As I am talking with clients about buying and even selling their home this is one of the questions that come up and they wonder how it applies to them. I thought this was a great article that explains the DTI in simple terms so that you have a better understanding of it. Of course, when getting ready to purchase your home, be sure to give Bill a call at 678-335-4848 so that he can guide you, give you exact, correct information and walk you step by step through the process.
Simple Definition : Debt-To-Income (DTI)
Debt-to-Income (DTI) is a lending term which describes a person's monthly debt load as compared to their monthly gross income.
Mortgage lenders use Debt-to-Income to determine whether a mortgage applicant can maintain payments a given property. DTI is used for all purchase mortgages and for most refinance transactions.
It can be used to answer the question "How Much Home Can I Afford?"
Debt-to-Income does not indicate the willingness of a person to make their monthly mortgage payment. It only measures a mortgage payment's economic burden on a household.
Most mortgage guidelines enforce a maximum Debt-to-Income limit.
Calculating Income For A Mortgage Approval
Mortgage lenders calculate income a little bit differently from how you may expect. There's more than just the "take-home" pay to consider, for example. Lenders perform special math for bonus income; give credit for certain itemized tax deductions; and apply specific guidelines to part-time work.
The simplest income calculations are applied to W-2 employees who receive no bonus and make no itemized deductions.
For W-2 employees, if you're paid twice monthly, your lender will take your last two pay stubs, add your gross income, and use this sum as your monthly household income. If you receive bonus income, your lender will look for a two-history and will average your annual bonus as a monthly figure to add to your mortgage application.
For self-employed borrowers and applicants who own more than 25% of a business, calculating income is a bit more involved.
To calculate income for a self-employed borrower, mortgage lenders will typically add the adjusted gross income as shown on the two most recent years' federal tax returns, then add certain claimed depreciation to that bottom-line figure. Next, the sum will be divided by 24 months to find your monthly household income.
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Income which is not shown on tax returns or not yet claimed cannot be used for mortgage qualification purposes.
In addition, all mortgage applicants are eligible to use regular, ongoing disbursements for purposes of padding their mortgage income. Pension disbursements and annuities may be claimed so long as they will continue for at least another 36 months, as can social security and disability payments from the federal government.
Non-taxable income may be used at 125% of its monthly value.
Calculating Debt For A Mortgage Approval
For mortgage applicants, calculating debt is less straight-forward than calculating income. Not all debt which is listed on a credit report must be used, and some debt which is not listed on a credit report should be used.
Lenders split debts into two categories : front-end and back-end. Front-end debts include payments to your credit card companies and your student loans. Back-end debts are debts related to housing.
To calculate your debts as a lender does, sum the following figures, where applicable :
Your monthly minimum credit card payments
Your monthly car payments
Your monthly personal loan payments
Your monthly student loan payments
Your monthly child support and/or alimony payments
Any other monthly payment which is not listed on your credit report
Note that several exceptions to this list apply. For example, if you have a car loan or other payment with 10 or fewer payments remaining, the payment does not have to be included in your debt-to-income calculation. Student loans for which payments are deferred at least 12 months into the future can be omitted as well.
The sum of these figures is your monthly front-end debt.
To calculate your back-end debt, add your mortgage payment to whatever other monthly payments you make in relation to housing. This can include your real estate tax bill, your homeowners insurance bill, and monthly assessments to an association among other items in your PITI.
Your front-end debt and back-end debt sum to comprise your total monthly debt.
Click to see today's rates (Sep 22nd, 2016).
Calculating Your Debt-To-Income Ratio
After you've determined your monthly income and your monthly debt load, finding your Debt-to-Income ratio is a matter of basic math. Simply divide your monthly debts into your monthly income.
Here are a few examples of the Debt-to-Income formula.
Calculating a 25% DTI
Monthly Social Security Income (taken at 125%) : $6,000
Monthly recurring debts : $500
Monthly housing payment : $1,000
Calculating a 40% DTI
Monthly W-2 income : $10,000
Monthly recurring debts : $1,500
Monthly housing payment : $2,500
Calculating a 45% DTI
Monthly self-employment income : $10,000
Monthly recurring debts : $2,000
Monthly housing payment : $2,500
Most mortgage programs require homeowners to have a Debt-to-Income of 40% or less, but loan approvals are possible with DTIs of 45 percent or higher. In general, mortgage applicants with elevated DTI must show strength on some other aspect of their application.
This can include making a large down payment; showing an exceptionally-high credit score; or having large amounts of reserves in the bank accounts and investments.
Also, note that once a loan is approved and funded, lenders no longer track Debt-to-Income ratio. It's a metric used strictly for loan approval purposes. However, as a homeowner, you should be mindful of your income versus your debts. When debts increase relative to income, long-term saving can be affected.
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