One of the qualifying criteria for a Mortgage Loan depends on the debt to income ratio aka DTI. This figure determines how much your monthly income is; and what the monthly payment of your loan will be or can be. It also helps the lender to understand your ability as a person to pay back your Mortgage Loan. Even your job stability and credit score is considered before the loan is dispersed.
Calculation of the EMI based on various factors
When a borrower applies for a Mortgage Loan, the lenders take into consideration various factors such as the gross income, net income, tenure of your employment and even if you have any other loans going on or not. In order to help them decide your monthly payment they consider a ratio of 36% or lower but also have a provision for exceptions.
The way DTI works
In order to understand how the DTI is calculated, it is first important to understand the different types of ratios there are pertaining to this front. The first is the front end and the second is the back end ratio. Let us check out the details and differences between the two and how they work.
The household ratio also known as front-end ratio (FER)
The front-end free show purely deals with the expenses that are related to your home. This includes the fees for the homeowners Association, the house insurance, and property tax as the monthly mortgage payment. All these figures are divided by the your monthly income.
The back end ratio (BER)
In this aspect, the lender takes into consideration the various other expenses you have such as your car loans, personal loans, student loans and even the credit card bills. These are basically all the monthly obligation a borrower has. It helps the lender to understand what should be considered while determining how much the borrower can afford to pay towards home mortgage.
So which of the two is more important?
Both of them hold equal importance and are considered by mortgage lenders; but the BER gives lenders a clear picture of your financial obligations. This is generally considered most important when a person is applying for a conventional mortgage. These are loans that online mortgage lenders and banks offer instead of the financial programs offered by the government. An ideal borrower is one who has an overall percent of 36% or lower DTI and 28% or lower front end DTI. The DTI also determines the interest rate you will pay on your mortgage.
In the case of non-conventional mortgages such as FHA’s, both the ratios are taken into consideration. Potential borrowers, who have higher DTIs, as if when the Front end is up to 31% or the Back end is 43%, are taken into consideration. While this may sound great but the fact is keeping your overall DTIs as low as you can is more important. This will help you to get a better credit score, which in turn increases your chances to get loans faster and that too with good interest rates.
Going beyond the DTI factor
As much as it is important to consider DTI’s for obtaining a mortgage; these factors do not completely determine if you can actually afford one or not. The big question that appears is whether a person can actually afford to sustain the entire one with what he or she earns. Based on income a person may qualify for a loan and may make payments regularly. However, there are other expenses, which equally hold importance. A person also has to think about other factors like bills, rent, travelling expenses etc. equally to ensure that they can handle the expenses of a mortgage.
Considering that the lenders do not calculate these factors, potential borrowers will have to budget themselves accordingly. This is why it is always recommended that, before you think about taking a loan, you make a proper decision to ensure that you are not burdening yourself. The DTI is the figure that you earn before your taxes are cut off. It is not based on what you take after that. While applying and qualifying for a loan may be an easy process, the reality is that you have to make this decision wisely; otherwise, it can be very difficult for you in the long run.