What is Debt-to-Income Ratio?
Often shortened to "DTI", Debt-to-Income ratio is arguably the most critical qualifying ratios in mortgage financing. However, 99% of consumers do not understand this simple calculation (not an actual statistic - more of an observational exaggeration).
Whose fault is this? Are consumers not doing enough research before applying for a home loan? Or are mortgage professionals unique individuals that happen to possess the mental capacity to calculate this life changing equation?
Ding, ding, ding it is neither! Mortgage professionals are inherently terrible at explaining anything in socially accepted dialogue. We call a mortgage application a "1003" for god sake!
On my initial contact with a potential buyer, 9/10 times I get asked the question(s) - what price home am I approved to? Can I afford $300,000 homes or is that too high? Or some variation of these questions.
It is a lot harder to nail down a maximum "purchase price" as one might think. Much of a buyer's approval is dependent on the property itself, as the property (property tax amount, price of home, HOA dues or not, etc.) will dictate much of the monthly mortgage payment.
I can however, share with you the exact formula us mortgage professionals use to calculate your approved monthly mortgage payment, which is directly correlated to what you can afford "home price" wise.
Let's see what you can afford.
The general rule of thumb is on a conforming loan product we cannot exceed 50% DTI ratio (other products max out at 38-45%).
In the example below, I will use 50% DTI ratio.
Debt-to-Income Formula:
Gross monthly income x .50 = maximum allowable debt
Maximum allowable debt - existing monthly debt obligations (on a credit report) = allowable monthly mortgage payment
Debt-to-Income Example:
Dan wants to purchase a home. Dan makes $55,000 gross income per year and has a few tradelines/debts on his credit report. Here is Dan's maximum mortgage payment he would be qualified for.
$55,000 gross income per year
$4,583.33/month
Debts:
Auto loan: $300 payment/month
Student loan: $150 payment/month
Credit card: $25 minimum monthly payment
Total debt obligation: $475
$4,583.33 x .50 = $2,291.67
$2,291.67 - $475 = $1,816.67 allowable monthly mortgage payment
How easy was that?
I know, I know, I didn't blow anyones mind or prove to be a math mathematician. But, that is how easy it is. Instead of learning life applicable equations in 3rd grade, we learned cursive that is now obsolete. And instead of learning the same life applicable equations in college, we leared 3rd derivatives. Maybe not obsolete to you engineers, but to 99% of the population...we don't care about derivatives!
We want to buy houses with white picket fences! And DTI is how you calculate what you can afford.
Satisfied with how much you can afford?
If you are unsure how to calculate your gross wages, or what debt will be used in your DTI ratio, please call or email with any questions. Happy to help!
