Often you hear about someone’s “DTI” from a lender and get confused as to what it means. Then you hear on the news about rising interest rates and how that hurts First-Time Home Buyers. But what is with the correlation and how does it affect you?
Let’s start with the Debt-to-Income (DTI) ratio. This is the correlation between your monthly debt obligations in comparison to your monthly income. That percentage is what a lender will look at to determine how much you qualify for. Now to be clear, this is based on gross income. Everyone’s tax situation is different, so lenders don’t want to start making guesses. However, that means you need to determine your budget. On the debt side, they look at everything from a monthly perspective. For example, they don’t care about the $100,000 student loan bill, they focus on the $200/month payment.
So where does buying a house come into play? As part of the debt portion of the ratio, that is where the lender will add the mortgage, property taxes, insurance, private mortgage insurance (if applicable) and homeowner association dues (if applicable).
So, what’s the ratio? Typically, lenders prefer a 43% DTI. For FHA loans, the lender will consider up to 55% DTI. Some lenders have gone higher, but I wouldn’t count on it.
Here is an example. Let’s say you make $10,000/month (or $50,000 per person for a couple). Here is your monthly debt breakdown:
- Car Payment: $250
- Student Loans: $150
- Credit Card: $50
Going based on the 43% metric, $4,300 per month can go towards your debt and buying a place. Subtracting, the above debt, which leaves $3,850/month that can go towards a purchase. Assuming you put 20% down at 5.5% interest rate, that would be a purchase price of about $640,000 for a single-family home. If you go the condominium route, then the purchase price would be less because you need to factor in HOA dues.
This is an easy excel exercise you can do. Once you input the numbers into excel, you can then determine what debt (if any) to pay off if it means you qualify for a higher amount. For example, when I bought my condominium, I had student loan debt. Because the payments weren’t going to affect my DTI enough to make a dent in my purchasing power, it made more sense to not pay it off and instead buy my first place. It worked out because now my student loan is paid off and I still have my appreciating asset.
With rising rates, that does mean your purchasing power decreases. Because part of your mortgage is principal and interest. But if you qualify for $3,850 towards a mortgage, no matter how it is split. So with rising rates, it means you qualify for a smaller purchasing price.
In either case, the best first step is to talk to a well qualified loan officer. They can tell you the nuances of the qualifying process and a good one can even help you strategize on the best way to manage your debt to get the most out of your debt to income ratio.
No responses yet