Why Lenders Consider Debt-to-Income Ratios

mortgage-picPerhaps you are thinking of purchasing a home or refinancing your current mortgage. The following explains what lenders consider when determining ones qualification.

Your debt-to-income (DTI) ratio is considered one of the most important qualification requirements when getting approved for a loan. Simply put, it is a calculation of your monthly debt obligations compared to your adjusted gross income.

When lenders consider your application, along with reviewing your credit they also consider your debt-to-income ratio, which can be used to determine your ability to pay as well as how much they will lend.

Lenders scale this ratio and will restrict the type of programs you qualify for. The higher the ratio, the more limited you are.

There are two debt-to-income ratios that you should be aware of.

The front-end ratio, also known as the housing ratio: This is the ratio for home-related monthly payments to monthly income. These include mortgage principal and interest payments, hazard insurance, property tax, homeowners’ association fees, and private mortgage insurance when applicable. Conforming mortgage lenders require that front-end ratios not exceed 28%, while FHA mortgage lenders will qualify borrowers at 31%.

Back-end ratio, also known as the total-obligation ratio, is the more important of the two. It looks at total monthly debt obligations that include anything found on the credit report, such as credit card payments, auto payments, student loans, etc. Conforming mortgage loans have a back-end ratio of 36% or less, while the limit on an FHA mortgage is 43%.

A new loan is always included in the DTI calculations. If the amount you are applying for raises your DTI above the limit, you will have to pay down some of your other debts in order to secure the new one. You can do this by reducing your down payment and using the money to pay off or pay down the other debts.

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