Are you planning to buy a home and are curious how much house you can afford? A big part of the answer will involve your Debt-to-Income Ratio (DTI).
A borrower’s Debt-to-Income (DTI) ratio is essential for lenders to know so they can decide how much of a home loan they will approve for a borrower. It is a snapshot of a borrower’s monthly debts divided by the pre-tax gross monthly income. This concept is explained in more detail by delineating front-end and back-end DTI.
The Front-end DTI ratio considers only monthly mortgage-related debt (principal, interest, taxes, insurance, HOA, etc.) divided by monthly gross income.
The back-end ratio combines monthly mortgage payments with other monthly debt and divides that by monthly gross income. Other debts are items such as credit cards, car loan payments, student loans, alimony, and child support. Monthly payments that are not included in this ratio include utility bills, car insurance, and health insurance payments.
Target DTI and Other Considerations
DTI numbers usually are presented as a fraction (Front-End DTI/Back-End DTI). Usually, lenders like to see ratios in the vicinity of 28/36. The back-end ratio is more important to lenders as it paints a bigger picture of borrowers’ spending habits.
For example, for a VA Home Loan, the VA usually does not want to see a Back-End ratio higher than 41%, but lenders may allow higher ratios in different situations.
When applying for a home loan, lenders utilize this process for applicants on the loan. If a married couple is looking to purchase a home, there are times both parties cosigning the loan is the best situation. However, it might be better to only have one person on the loan application, especially if the other person has more liabilities.