If you are looking to buy a property, know the debt-to-income calculation will help you understand your purchase power. Understanding this simple math formula could mean the difference between getting approved or getting denied for a home loan.
The debt-to-income ratio, also called the DTI ratio by the mortgage industry, is a comparison between how much money you are making versus how much is being spent on debt.
The formula: Total monthly debt payments ÷ monthly income = DTI
Mortgage lenders will review the DTI in two different ways. The first way is to consider the home-only ratio. This is also called the Front Ratio.
The lender will compare the proposed home mortgage to the overall income.
The other way to view the DTI is the calculation which adds all the debt, plus the proposed mortgage payment, and divides it by the monthly income. This is known as the back ratio.
Each mortgage will have slightly different guidelines for their qualifying DTI ratios. Here are some general rules about the major types of home loans.
Conventional mortgage from Fannie Mae or Freddie Mac – These loans will examine the
Front DTI and the Back DTI. The Front DTI should be around 28% and the back DTI should be under 43% If the borrower has a large down payment or significant cash reserves, the back-end DTI may be slightly higher.
FHA Mortgage – For FHA, the front ratio needs to be no higher than 31% and the back ratio should not be higher than 43%.
VA Mortgage – For the VA loan, only one ratio, which is the back ratio, is considered. The back ratio should not be any higher than 41%.
USDA mortgage – USDA will allow borrowers to have up to 29% on their front ratio and 41% on their back ratio.