This is a VERY important & critical part of the affordability process that determines what you can or cannot afford. Your DTI is expressed as a percentage & is your total “minimum” monthly debt divided by your gross monthly income. Lenders have different guidelines that they follow*. The conventional limit for DTI is 36% of your monthly income, but this could be as high as 43% for some loans. A DTI of 20% or below is considered excellent & although this would be awesome & save you a lot of money, it’s also rare, so don’t think you have to have your DTI at or near 20% before you begin.
It’s in part what all financiers use to determine your financial qualifications. In reality, lenders evaluate how much additional debt you can handle & how much of a credit risk you pose. It’s a common practice in the finance world, but usually home buyers are unaware of this critical information. It’s a valuable formula for everyone & easy to determine. The Debt to Income ratio is used with consumer loans, credit cards, loan officers & other financial institutions.
To calculate your ratio:
1. Determine your monthly debts, which will include your new house payment, & other monthly debts like credit card minimum payments, student loans, car loans, alimony, child support, personal loan, etc.
2. Now divide this number by your gross monthly income including all income that can be documented through pay stubs or your tax return. You can use a mortgage calculator to help you with your estimation.
The formula is:
Debt to Income = Monthly Debt Payments ÷ Gross Monthly Income
For example, if you have a $3,400 monthly gross income.
$3,400 (gross monthly income) X .36 (generally recommended maximum DTI)
= $1,224 (amount your total monthly debt payments should generally not exceed)
*IMPORTANT: The standard rule of thumb is that your DTI ratio should be less than 36 % since lenders generally require that borrowers have a DTI ration no higher than 40% in order to qualify for a mortgage. A DTI ratio as high as 36% puts you at risk of paying higher interest rates or being denied altogether. Note that certain types of mortgages may allow a DTI ratio above 40%, such as certain Federal Housing Authority & Veterans Administrative mortgages.
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