Dept To Income Ratio Explained
One of the first steps you will need to do when approach the bank in request for a mortgage loan at present times (2015) is to calculate and have a DTI ratio figure. DTI stands for Debt-To-Income, this is a very important figure for you and for the lender too.
In short, the ‘debt-to-income’ ratio means how much of your overall income (before taxes) is spent on paying back debts. We will drill down into it below, but the main thing to understand is that the whole mortgage deal is centered by this figure.
When a family has to calculate how much money they thinks they can pay back monthly, they tend to be over optimistic… (pink glasses) and image life as a ‘walk in the park’, while the bank and lenders know life can be a crazy downhill ride. Because of this, the ratio percentage will determine how much money will be lend, and how long the mortgage life term will be.
People who have a high DTI (Dept to Income) ratio are paying too much of their income on debts, this means that if any financial glitch occurs down the road (car fixing, dental treatment, home maintenance emergency) they will be falling behind their payments.
Both the lender and the borrower would prefer to avoid this situation, and this needs to be dealt by following the dept to income ratio guidelines.
How To Calculate Front End Debt-to-Income Ratio
The DTI ratio can be calculated quite easily and the figure should be a clear % number. You need to take total mortgage monthly payment – You MUST include the principal and interest, all escrow deposits for taxes, any hazard insurance, added fees for mortgage insurance premium, homeowners’ dues, etc. This total amount will be the actual sum of money you will need to pay back monthly.
In order to get the ‘ratio’ percentage, take the ‘total amount of monthly mortgage payments’ and divide it by the gross monthly income (before taxes). This will give you a DTI ratio figure.
Front End Debt to Income Ratio Example
If your monthly Income is $10,000, and the total of mortgage payments due each month is $2200 – Then your DTI ratio is 22%. This is usually refereed to as front-end DTI ratio. The Front End means the ratio to income is compared only for the house payments (including tax and insurance).
But a family has more expenses which bite off the family available cash, which needs to be taken to consideration, the family expenses do not end with the home loan payments. For this reason there is the Back-End DTI Ratio.
Back End DTI Ratio Calculation
The bank or lender is more interested in the back-end ratio figure, as this figure can predict better the amount of money a person or family could really be paying back each month.
In the back end ‘debt to income ratio’ you need to calculate all the liabilities and debts you have, this includes the house payments expected and on top of this all recurring monthly revolving credit debts and also all installment debts like car payments, any personal loans, student loans, credit cards, and all other monthly expenses that are on the debt column.
As you can understand this will be the fixed payments to effective income ratio, and this is the actual monthly situation you will need to be handling financially.
Back End DTI Ratio Example
If your monthly income is $10,000 , the home loan monthly payments are $2200 like in the front end DTI example, and on top of this you have $1500 (car payments, student loan payments and monthly credit payments). Then the back end DTI ratio is $2200 + $1500 = $3700 divided by the income $10,000 = 37% Back End Debt to Income Ratio.
Who Needs This DTI Ratio Figure
Both sides of the home mortgage deal have interest in the Debt to Income ration figure. After the debt to income is calculated, it assists both the lender and the borrower in a number of assumptions that have great impact on the mortgage amount, interests rates and closing possibilities.
The Debt to Income ratio can determine the amount of money the lender will be willing to give you, based on the percentage you have. If your monthly dept to income is too high, there are two options either to borrow less money or to extend the loan term for example from 15 years to 20 years and by that to lower the monthly payments.
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