Capacity: Calculating Your DTI

Capacity

To put it very simply, you need to prove that you can repay the loan.

To determine if this is the case, the underwriter will analyze employment status, annual income, and debt. The underwriter will also review assets, such as savings and checking accounts, stocks and bonds, 401(k), and IRA accounts. Cash reserves may also be reviewed, to determine how well you can stay on top of your bills and expenses, if your income suddenly stops for any reason.

Lenders look at two calculations (also called ratios). They are:

1. The first is your Housing Ratio (also called the front-end ratio). It is the percentage of your proposed total mortgage payment (principal & interest, real estate taxes, homeowner’s insurance and, if applicable, flood insurance and mortgage insurance) divided by your monthly, pre-tax income. An ideal Housing Ratio would be 28% or less; although, at times loans can be approved at a higher number. That is due to the fact that your front-end ratio is looked at in conjunction with your back-end ratio.
2. The second is your Debt Ratio (also called the back-end ratio). This starts with that mortgage payment calculation from the Housing Ratio and adds to it the current payment obligations that would show up on your credit report (car loans, minimum credit card payments, student loans, etc.). A good back-end ratio would be 40% or less. However, loans sometimes are approved with higher debt ratios.

Remember that every application is different. Income can be impacted by overtime, bonuses, job history, unreimbursed expenses, commission, and other factors. Consult an experienced Mortgage Advisor to determine how the underwriter will calculate your numbers.

Let’s look at a real-life example.

Below is a hypothetical debt-to-income calculation for Shimon & Chani:

Monthly Obligations:

1) Proposed housing payment (including real estate taxes and homeowner’s insurance): $2,000
2) Car payments: $300
3) Other loans: $150
4) Minimum payments on credit cards: $150

Income:

Shimon’s monthly gross income: $5,000
Chani’s monthly gross income: $5,000

Debt-to-income calculation:

Total obligations: $2,000+$300+$150+$150= $2,600
Total income: $5,000+$5,000= $10,000
DTI=26%

In this case, the debt-to-income ratio of 26% would likely be viewed positively. Lenders will usually accept DTI’s as high as 45%, and in some cases up to 50-65%.