A lender needs to know how much money you can afford every month. The process used is a debt-to-income (“DTI”) analysis. Honestly, if this is too much for you, skip it and when you talk to a lender, they will explain it to you. However, if you have an idea of how this works and a general understanding of what it means, it will help you.
If you have too much debt and not enough income, you will have to work on reducing your debt and possibly increasing your income before you get a loan. This is no big deal, you can take the time to formulate a plan to pay off some of your debt to reach the DTI percentage you need to get a loan.
– Your DTI must be a certain percent in order to qualify for a mortgage.
– There is a front-end and a back-end DTI ratio, expressed in percentages, like this 36/45. The “36” is your front-end DTI. The “45” is your back-end DTI.
A front-end DTI ratio is a calculation of how much of your monthly gross income is applied to your housing costs. It takes your proposed monthly mortgage payment (including insurance and taxes) divided by your gross monthly income. We don’t know how much your monthly mortgage payment will be at this time because you don’t know how much money you can borrow. However, you created a budget in Chapter 1 and we’ll use that figure. Let’s say you believe you can afford $1,200 a month for your mortgage payment that includes principal, interest, taxes and insurance.
Here’s an example of how to determine your front-end DTI.
Gross monthly income: $5,000
Proposed monthly mortgage payment: $1,200
Put your proposed monthly mortgage payment, $1,200 in a calculator first, then divide it by $5,000 = .24 or 24%.
24% is your front-end DTI.
A back-end DTI ratio is a calculation to determine the percentage of how much of your gross income goes to paying your debt, such as student loans, credit cards, automobile payments. To get this figure, add up all of your monthly bills and divide it by your monthly gross income. Generally, lenders want a back-end ratio that is no more than 36%.
You can find dozens of DTI calculators online or here’s how to do it manually.
Here’s an example of how to determine your back-end DTI.
Gross monthly income: $5,000
Total monthly debt: $2,000
Put the monthly debt $2,000 in a calculator first, then divide it by $5,000 = .4 or 40%.
Your debt exceeds the general 36%. Lenders want to see that your monthly payments don’t exceed 36%. However, some lenders will consider giving you a loan if you have good credit.
Your DTI ratio is 24/40.
Let’s say the lender’s DTI requirement is 30/36. (Your front-end DTI has to be 30%; back-end DTI at 45%.)
Your front-end DTI is 24%. That’s 6% below the lender’s 30% requirement. You’re good.
Your back-end DTI is 40%. That’s 4% above the lender’s requirement of 36%.
What if your ratios don’t meet the lender’s requirements?
If your front-end DTI meets the lender’s requirements but your back-end doesn’t, you might need to buy a less expensive house – the proposed monthly mortgage payment has to be reduced.
If your back-end DTI doesn’t meet the lender’s requirements, you’ll might have to eliminate some of your debt.
Don’t worry about having a complete understanding of debt-to-income ratios. After you submit loan applications, your lenders will tell you what your numbers are. Just ask them what you need to do – reduce debt, increase income, buy a less expensive house, etc.
Next, choose two lenders or mortgage companies.
You’re going to shop for the best loan for you. All lenders and mortgage companies don’t offer the same loans. We’re going to make sure you get the best loan. And we’re going to make sure you don’t get ripped off.
TIP: Make both applications within two weeks. Why within two weeks? Because if you wait a month or two between applications, your credit report could be negatively affected. Inquiries on your credit report can reduce your FICO score. But if you make two applications within two weeks, your FICO score should not be affected.
– You’re not going to make the most common mistake homebuyers make, going to look at homes before you know how much money a lender or mortgage company will lend you.
– You’re going to choose two lenders or mortgage companies to shop for the best loan and make sure you don’t get ripped off.
– You are to make appointments with two lenders and bring a completed mortgage application with you, as well as all the documents they will need.
Next, we’ll take a look at the Good Faith Estimates (GFEs) the lenders or mortgage companies will give you after you submit your loan applications.