When applying for a mortgage, lenders use the debt-to-income (DTI) ratio as a critical factor in determining your eligibility and affordability. The DTI ratio is essential because it shows whether you can handle additional debt and affirms your financial stability. In this article, we will go through the steps to calculate your DTI ratio and discuss the importance of this metric when applying for a mortgage.

1. Understand what DTI is:

Debt-to-income ratio is the percentage of your monthly gross income that goes toward paying monthly debts. It is often expressed as two categories: front-end DTI and back-end DTI.

– Front-end DTI: Also known as the housing ratio, it only considers housing-related expenses, such as mortgage payments, property taxes, and insurance.

– Back-end DTI: This includes all of your monthly debt payments, like credit card bills, car loans, student loans, and other obligations.

2. Calculate your gross monthly income:

To calculate your gross monthly income, add up all of your income sources before deductions like taxes and insurance premiums.

For salaried employees:

Divide your annual salary by 12.

For hourly employees:

Multiply your hourly wage by the average number of hours worked per week and then multiply by 4 (weeks in a month).

Make sure to also include any commissions or bonuses received.

3. Gather information on monthly debts:

List all your recurring monthly debt payments. Include credit card bills (minimum payment), car loans, student loans, personal loans, other mortgages or rent, alimony or child support payments, etc.

4. Determine front-end and back-end DTIs:

Front-end DTI:

Divide your estimated monthly mortgage payment (including principal, interest, property tax, and insurance) by your gross monthly income. Multiply the result by 100 to get the percentage.

Back-end DTI:

To find your back-end DTI, add up your total monthly debt payments and divide it by your gross monthly income. Multiply the result by 100 to get the percentage.

Example:

Gross monthly income: $6,000

Estimated monthly mortgage payment: $1,500

Total monthly debt payments: $2,300

Front-end DTI: ($1,500 / $6,000) x 100 = 25%

Back-end DTI: ($2,300 / $6,000) x 100 = 38.33%

5. Evaluate your DTI numbers:

Lenders typically prefer a front-end DTI lower than 28% and a back-end DTI lower than 36%. However, some lenders may approve borrowers with higher DTIs if they have a high credit score, substantial savings, or other compensating factors.

In conclusion, calculating your debt-to-income ratio is an essential step in preparing for a mortgage application. Understanding your DTI ratio helps you assess the mortgage amount you can comfortably afford and enables you to make informed financial decisions in the home-buying process. Keep in mind that managing debt effectively is crucial for maintaining a healthy financial profile and obtaining favorable loan terms on your mortgage.