The debt-to-income (DTI) ratio is one of the main criteria that lenders use to approve applications for conventional and USDA loans in Orem, Utah, or anywhere else in the Beehive State. It weeds out heavily indebted borrowers, which helped form the previous housing bubble in America that eventually triggered a devastating financial crisis.
Your DTI ratio is calculated by dividing your gross monthly income by your total monthly liabilities. The general consensus is 43% of DTI ratio is the maximum, so going above the threshold merits an automatic denial of the mortgage application.
Although its concept is quite straightforward, it is not as simple as it seems. If you do not understand it properly, your chance of getting taking out an adequate mortgage becomes slimmer. Here are some misconceptions about the DTI ratio:
It Includes Debts Only
It is easy to assume that debts are just the liabilities taken into consideration when calculating your DTI ratio. However, it goes beyond the unsecured and secured loans you currently have. It also involves a credit card, alimony (spousal support), and child support payments. If you already have a mortgage on a different property, its monthly payments are likewise part of the calculation.
Moreover, your estimated mortgage monthly payment for the loan you are applying will also be considered. You might encounter two kinds of DTI ratios: front-end and back-end DTI ratios. The former refers to your projected housing payment while the latter talks about all of your liabilities. It is the back-end DTI ratio that should stay below the magic number 43.
What is not included in your DTI ratio calculation, though, is your utility bills as well as insurance premiums. Mortgage lenders assume you also have expenses outside of your general financial obligations, which is why they want at least 57% of your monthly income to cover them.
It Considers Total Credit Card Balances
When doing the DTI ratio math, you should use your minimum credit card payments instead of the full balances. Check your credit reports to know the number you can use.
It Prohibits Low-Income Borrowers
Frankly, the DTI ratio is designed to disqualify borrowers who can’t afford to manage a huge and long-term debt like a mortgage. Usually, those borrowers are low-income earners.
But then again, having a low income is not entirely a hopeless situation. If what you make right now can’t justify the amount of money you wish to borrow to buy a property, you can apply for different house financing instead.
A stated income loan is a perfect remedy to overcome a hard-to-meet DTI ratio requirement. Such a financial product might no longer be available to the general public, though, since it was deemed illegal by the Dodd-Frank Act of 2010. The stated income loans that might be on the market are offered just for non-occupying borrowers, which are typically investors.
Fortunately, there are mortgages that still require little documentation. They are primarily intended for self-employed borrowers who do not earn money through traditional means. Rather than submitting pay stubs and tax returns, these borrowers are allowed to present bank statements only. Hence, these mortgages are called bank statement loans.
The rules of qualifying for a bank statement loan is different from those for conventional mortgages. The debt-to-income ratio still matters, but going above the 43% mark might not be frowned upon. Aside from more demanding employment, credit score, and down payment requirements, higher-than-normal interest is another caveat to remember.
Use your DTI ratio to gauge your own capacity to repay a mortgage. Regardless of the kind of loan program you pursue, the affordability of your monthly payments matters to ultimately avoid delinquency and foreclosure.