The process of buying a home should be exciting, but it can sometimes also be a bit confusing. The terms, acronyms, and other details can be a lot to digest. The good news is we’re in your corner and can break down the concepts into plain English so you can better understand lender’s expectations.
For instance, DTI (Debt-To-Income) is an important acronym for a home buyer to understand. Very simply, it is the percentage of your monthly gross (before tax) income that goes toward paying debts. There are two main kinds of DTI, and they are expressed as a pair. An example would be 28/36. Your lender may require a specific DTI ratio to qualify as a borrower for a mortgage.
What do these numbers mean? Let’s walk through the first number. The first DTI is known as the front-end ratio. It indicates the percentage of your income that goes to housing costs. These costs will include your mortgage principal, interest, mortgage insurance (if applicable), hazard insurance, property taxes, and homeowners’ association dues (if applicable). This number provides your lender with information about how your mortgage relates to your income.
The second DTI is known as the back-end ratio. It indicates the percentage of your income that goes toward paying all recurring debts, including those covered by the first DTI, credit cards, car loans, student loans, and other payments. This number provides your lender with information about your mortgage and other recurring payments relate to your monthly income.
Your DTI information is used in the qualification process to ensure that your mortgage is considered conforming. Conforming loans can look a bit different depending on where you are looking to buy a home — FHA or USDA loans. They can also depend on your status as a veteran if you have served in the Armed Forces.
These two numbers can really affect your chances of getting approved for a mortgage. And unlike your credit score — which you want to be high — a low percentage is in your favor. In most cases, you’ll need a DTI of 50% or less, but the specific requirement depends on the type of mortgage you’re applying for.
If you’re not satisfied with your DTI, don’t worry. There are some strategies you can use to lower it before you apply for a mortgage. For one, you can work to eliminate monthly payments. So, paying off that car loan early will certainly help. Also, boosting your income by getting a part-time job or side hustle can move the needle. However, you should know that lenders want assurance that this cash flow is regular and will continue. A two-year history for each income source can inspire confidence.
Another approach? If you’re buying a home with your spouse or partner, the bank will calculate your DTI using both of your incomes and debts. That means if your partner has a low DTI, you can lower your total household DTI by adding them to the mix.
In short, there are several factors that enter the equation when qualifying for a mortgage. It’s important to work on paying down debt, boosting your credit score and saving for a down payment. Remember, the pursuit of financial health it’s a marathon and not a sprint. Set realistic goals and you can make the leap when the time is right for you.
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