Thanks for your question on debt to income, which indeed is often referred to as a DTI ratio. This is a critical measure that mortgage lenders use to evaluate your ability to make your mortgage payments. I will try to get you some information below on what a debt to income score is and some DTI tips to help you out.
Debt-to-Income Ratio and DTI Definition
Debt-to-Income ratio (DTI) is a comparison of your monthly gross income and your monthly repayment obligations to creditors. For example, if you gross $2000 each month and your debt payments total $500, your DTI would be 25%. When you apply for new credit, potential lenders look at your DTI to determine if you can realistically afford your current debt payments, and if so, how much additional debt you can afford to repay. DTI is one of the most important factors considered by potential lenders, as it is a good indication of your ability to repay the new loan.
There are two types of DTI that most lenders take into consideration. The first is typically known as the front-end ratio, which accounts for a person's housing costs. The housing costs include rent (for non-homeowners). For homeowners it would include the mortgage principal and interest payment, mortgage insurance (if applicable), property taxes, insurance, and (if applicable) homeowner's association (HOA) fees. The second is usually considered the back-end ratio. This consists of all other debt payments such as unsecured debt, auto loans, student loans, legal judgments, child support, alimony, and all items covered in the front-end ratio.
Debt-to-Income Ratio Summary
Every lender determines its own guidelines regarding allowable DTI ratios for new loans. Generally speaking, a combined DTI over 55% is considered very risky, and could make obtaining a new loan difficult. Also, you will usually want to keep your front-end debt to income ratio below about 29%, as a rule of thumb, so don't borrow to buy too expensive of a house if your income cannot support it. Lenders will help you calculate and analyze your debt-to-income ratio to determine the size mortgage you can afford. In fact, your DTI and your loan-to-value (LTV) are frequently the most important numbers that lenders look at when quoting you a mortgage amount and interest rate. When considering to purchase a home or refinance a home you should calculate your DTI to see where you stand. So as you can see, your debt-to-income ratio can tell you a lot about your debt and your chances of qualifying for a mortgage loan.
If you want to identify your overall financial situation and keep your debt in check, you need to establish your debt-to-income ratio. The best thing to do is to keep your debt under control and not to take on too much debt. If you take on too much debt it could hinder your ability to qualify for a mortgage and send your finances plummeting, it could also cause you unnecessary stress if you stretch too much and borrow more than you can comfortably afford each month.
After you calculate your debt-to-income ratio, it's time to discover what your ratio is telling you. If you have a DTI ratio of 10% or less, it means you have a great debt-to-income ratio, meaning your income is significantly more than what you owe. A DTI of about 29% is considered by financial experts as the highest most consumers can handle comfortably. If you have a debt-to-income ratio of 55% or higher, it means you are taking on too much debt in relation to your income. A DTI greater than 55% is considered very risky since it will be difficult to continue to cover your monthly debt obligations with your current income.
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