If you’re like most people, you’re going to look for ways to improve your credit score to buy a home, and part of that is lowering your debt-to-income ratio so lenders can give you more favorable terms on a mortgage.
What is Debt-to-Income Ratio?
Your debt-to-income ratio, or DTI, is all of your monthly debt payments divided by your gross monthly income. The resulting number, turned into a percentage, is your official debt-to-income ratio.
Let’s say you earn $4,000 per month before taxes (that’s your gross income). All of your monthly obligations, such as rent, utilities, car payments, and insurance add up to $2,000. That means your debt-to-income ratio is 50 percent, because half of your gross income goes toward paying for those obligations.
There are two types of DTI ratios lenders actually look at: Front-end and back-end.
The front-end ratio, often called the housing ratio, shows lenders what percentage of your income goes toward housing expenses. That includes your monthly mortgage payment, insurance, real estate taxes, and homeowners’ association dues. The front-end ratio only looks at housing-related debt and obligations.
In the example above, where you made $4,000 per month and spent $2,000 on all your expenses, let’s say only $1,000 per month went to your rent. That would mean that your front-end DTI is just 25 percent.
Lenders look at the back-end ratio to determine what part of your income goes toward all of your monthly debt obligations. Credit card bills, car payments, child support, and all of the other debt that shows up on your credit report requiring monthly payments go into this, but then lenders add it to the front-end ratio.
That’s what we calculated above—your back-end debt-to-income ratio. In the example, your DTI was 50 percent.
What Lenders Want to See in Your Debt-to-Income Ratio
Most lenders want to see a front-end ratio of 28 percent or lower and a back-end ratio of 36 percent or lower.
Realistically, though, lenders factor in your credit score, how much money you’re putting down on the home, and how much you have in savings before they decide whether your DTI fits their requirements.
Do You Need to Talk to a Realtor® About Finding the Perfect Home in Lakewood?
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