This percentage, calculated based on your income and the amount of debt you have, can make or break your ability to buy a home.
Here’s what you need to know about debt-to-income ratios and how to make sure yours is in good shape:
What is debt to income ratio?
Simply put, debt-to-income ratio (DTI) is the percentage of your gross monthly income that goes towards your debt. There are actually two different DTIs—front end and back end. The front-end is based on your mortgage only, while the back-end is based on your mortgage and other debts together. These debts include car loans, credit card balances, student loans, and personal loans or lines of credit.
Your debt to income ratio is calculated by dividing your mortgage and debts by your monthly income. For example, let’s say you gross $5,000 a month and have a mortgage of $1,000 and other debts totaling $1000. Your front-end DTI is 20%, and your back-end is 40%.
The higher your DTI, the more debt you have.
Why does DTI matter?
Lenders use your DTI to determine whether or not you qualify for a mortgage because it helps them see how much money you have available each month to pay your mortgage. The greater your debt and financial obligations, the more of a risk you pose. When your debt is low, you have more available income to repay your mortgage.
Keeping your DTI in check
As a general rule, you should aim to keep your front-end (mortgage) DTI at less than 30% and your back-end (total debt) at no more than 45%. Most lenders focus on your back-end DTI.
If your DTI is higher than 45% and you want to purchase a home soon, work to pay down your existing debt. Put your credit cards away, and don’t apply for any new lines of credit. As you lower your balances, your debt to income ratio will start to go down.
You can keep your path to home ownership free of obstacles by making sure your debt-to-income ratio is within the recommended limits. To find out if your debt to income ratio will qualify you for a mortgage, contact one of NLC Loans’ personal mortgage advisors toll-free today at 1-877-480-8050.