Although it may feel like it at times, potential mortgage lenders really don't want a pint of your blood, your first-born child or dibs on any lottery winnings that might come your way. They just want to be sure that you can afford to pay back the money you want to borrow to buy a home and that you're not up to your cranium in debt. One tool that mortgage lenders use to determine your financial fitness is your debt-to-income ratio, or DTI.
Just like the term implies, your DTI ratio compares your income level to the amount of debt you carry to determine how much mortgage you can afford. There are two types of DTI that lenders will consider. Your front-end DTI compares your total amount of proposed housing expenses to your gross monthly income. Your back-end DTI compares you current debt level (not including housing expenses) to your gross monthly income.
Mortgage industry standards dictate that the amount of your monthly housing costs should not exceed 28 percent of your gross monthly income, while your debt payments should not exceed 36 percent. As a result, you may frequently see these ratios expressed as "28/36" during your search for a lender.
Income and Debt Identification
Lenders will typically look at more than just your salary or hourly wage when determining your monthly income. They will also consider tips, investment income, Social Security benefits, alimony and child support payments and commissions. Self-employment income is also acceptable as long as you can document it with items like 1099 tax forms and a few years of recent tax returns. The key is to document all income for the previous two years. Your debt items will include items such as car payments, credit card payments, student loans and any other installment payments you make on a monthly basis.
Suppose you and your partner have a combined gross annual income of $48,000, or $4,000 per month. If your proposed housing costs, which include your mortgage payment and any required mortgage insurance, total $1,000, your front-end ratio would be 25 percent. If your monthly debt payments total $1,200, your back-end ratio would be 30 percent. In both cases, your DTI would be well within acceptable limits.
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