Want to make sure you can manage your mortgage payments? Then you need to understand your debt-to-income (DTI) ratio.
What is DTI? It’s a quick calculation of your gross monthly income (the money you earn before taxes and deductions are subtracted) compared to your monthly debt payments. With this information, a lender can estimate whether you’ll be able to afford a certain mortgage before you sign on the dotted line.
Types of Debt-to-Income Ratios
There are generally two types of DTIs used by lenders when trying to figure out your eligibility for a mortgage:
1. Front-End or Housing Ratio: In this calculation, your lender will look only at home-related debt. It includes expected monthly mortgage payments, homeowner association (HOA) fees, property taxes, mortgage insurance, and homeowner’s insurance. The ratio is calculated by dividing all of these expenses by your gross monthly income.
2. Back-End of Total Debt Ratio: For this ratio, your lender will look at all of your debt, not just that related to the house. This will include every item in the Housing Ratio as well as student loans, credit card debt, alimony and child support, auto loans, and so on. This larger debt amount will then be divided by your gross monthly income.
Studies suggest that people who have a Total Debt Ratio of 43% or lower are more likely to be able to make good on all their debts. When the ratio is higher than 43%, people often run into financial trouble. However, 43% is generally the highest most lenders will go. Ideally, you want your debt-to-income limits to be no higher
than the following:
• Front-End Ratio: 28%
• Back-End Ratio: 36%
How to Use Your Debt-to-Income Ratios to Calculate How Much Home You Can Afford
Home lenders use front-end and back-end ratios to determine whether to grant you a mortgage. So before you start to shop for homes, it can be very helpful to estimate what monthly mortgage payment is safe for you.
To do so, simply look for a debt-to-income ratio calculator online. Input different mortgage amounts to figure out how much you can safely afford.