Most people are usually concerned about their credit score when they are applying for a mortgage home loan. A credit score is a sign that shows your capability of loan repayment, and it can also affect the interest rates you’ll be able to secure. Credit scores are important; however, what you might not know is another number, and that is your debt-to-income (DTI) ratio. DTI ratio can play a significant role in your ability to receive a mortgage. A high debt-to-income rate is a primary reason for home loans getting rejected.
What’s a Debt-to-Income Ratio?
Your debt-to-income ratio comprises of all your monthly loan payments divided by your gross monthly income. Most lenders usually offer loans to borrowers who are creditworthy and have DTIs as high as 50%. That limit depends on policies set by government-supported financial institutions like Fannie Mae. They are set up to secure clients against predatory lending practices. However, more financing options will be available to individuals who have a lower DTI ratio. Let’s see how this number is calculated.
Calculation of DTI (Debt-to-Income Ratio)
Calculation of your DTI ratio is simple, you need to add up what the payment of your monthly loan will be after you purchase your new home (for example credit card bills, car loans, student loans, and your future loan payment) then divide that amount by your gross monthly income (the money you earn before taxes).
The complicated part about computing debt-to-income ratio is that there can be many moving parts.
- If you haven’t finalized your shopping for a new house yet, it would be hard for us to know what will be your mortgage payments, insurance payments, or property taxes exactly, and thus we’ll have to use an estimate.
- If you presently own a house, we’ll have to factor in both your current and future home loan payments as loans (unless the buying of your new house is dependent on the sale of your old house).
Also, when we compute your income (the other part of your DTI ratio), we have to use conservative computations, and that’s because we need to ensure that you get a loan that remains affordable to you not only now but in the future as well.
- If you’re self-employed or paid by RSUs or commission, it will be hard for us to take 100% of your income, since these types of earnings are generally less consistent.
- When self-employed, it’s usually helpful to write off your business expenditures to lessen your tax bill. However, those tax deductions may likewise bring down your qualifying income, as underwriters are assessing your net income.
- When receiving rental income from your investment property, your tax returns should reflect that rental income (if your tax assessment hasn’t been submitted or, your rental checks will be required) and we’ll only be able to utilize a part of that income to be conservative.
- If you’re planning to turn your current house into a rental property, we’ll need a lease agreement in place from you to consider the potential income.
- If you plan on turning your current home into a rental property, you’ll need to have a lot in place for us to consider the potential income.
We at Texas Trust Home Loans can help you with your Debt-to-Income (DTI)
At Texas Trust Home Loans, we aim to provide you as much clarity related to how much you’ll be able to borrow.
We also encourage you to get our underwriting pre-approval letter if you’re planning to purchase it soon. The underwriting team at Texas Trust Home Loans will assess your pay stubs, tax returns, and any other related documents linked to your financial circumstances. With that information, we can determine how much exactly you’re eligible to borrow. The information will also help you as you won’t get any surprises that are linked to your DTI when you have a purchase contract on a home.
How to Reduce Your Debt-to-Income ratio?
Reducing your DTI ratio can have a significant impact on the kind of mortgage you can secure. If you have the flexibility with the timing of when to buy, then take your time to reduce your DTI ratio (also increase your credit score) and it will save you thousands of dollars throughout your mortgage.
Tips for lowering your DTI ratio:
- Increase your income
- Avoid taking on more loans.
- Consider reducing the amount you charge on your credit cards and try to postpone applying for additional loans.
- Refinance high APR credit card debts with a low APR card.
- If you are planning to buy a new car, postpone it till you’ve purchased your home.
- If you already have a car loan, pay it off before applying for the loan.
- Refinance or consolidate your current loans to lower your monthly payments.
- Add a co-borrower with a low DTI to your mortgage. However, if your co-borrower has a low credit score, it can hurt your financing options).
- Borrow from your 401K retirement plan at no interest to pay off smaller debts.
- Make sure you have lease agreements available if you’re planning to use rental income.
- Planning to live with your parents, or partner, in your new house? Talk to us about how we might include some of their income in your DTI calculation.
Explore Your Options With Us! To Reduce Debt-to-Income.
Still confused? We can gladly help you in understanding your debt-to-income ratio and the loan opportunities available for you.
For further information, you can visit our website www.texastrustloans.com.