Lenders will have several qualifications for borrowers (that’s you, the buyer).  One of those qualifications will be your debt-to-income (DTI) ratio.  Your DTI will be broken down into two parts, the front ratio and the back ratio.  Remember those numbers on the back of my business card (28/36, 31/43, 29/41, & 41)?  The front ratio is the first number, followed by a slash, then the back ratio.  These ratios will vary depending on the type of loan you are considering or your lender is considering for you.

So what is DTI?  Well, it’s basically what the name implies.  Your debts compared to your income.  As mentioned previously, your DTI is broken into the front ratio, which is basically how much of a mortgage payment you can afford according to your income and the back ratio which is all of your debts compared to your income.  You can determine your own DTI easily.  However, before you figure out your DTI, you need to know what type of mortgage loan for which you are qualifying.

Let’s discuss those.  There are typically four types of conforming loans:  1) Conventional, 2) FHA, 3) VA, and 4)USDA.  What’s do all these terms mean.

Conforming LoanIn the United States, a conforming loan is a mortgage loan that conforms to GSE (Fannie Mae and Freddie Mac) guidelines. The most well-known guideline is the size of the loan, which as of 2013 was generally limited to $417,000 for single family homes in the continental US. 

Conventional LoanA conventional loan is a loan backed by either Fannie Mae or Freddie Mac, the two entities which comprise the Federal Housing Finance Agency (FHFA).

FHA (Federal Housing Administration)A mortgage issued by federally qualified lenders and insured by the FHA loans.  They are designed for low to moderate income borrowers who are unable to make a large down payment.

VA (Veterans Administration)A loan issued by qualified lenders designed to offer long-term financing to eligible American veterans or their surviving spouses (provided they do not remarry).

USDA (United States Department of Agriculture)Is a mortgage loan offered to rural property owners (buyers) by the United States Department of Agriculture.

Okay, so now that you know a little more about the type of loans, you can determine which type of loan for which you want to qualify.  And if you’re asking if you can qualify for more than one, you sure can.  Now, let’s show you how to figure your DTI based on these four loan programs.

Front:  Annual Income/12=Monthly Income.  Monthly Income*Front Ratio=Your max mortgage payment.  Your mortgage payment will be comprised of PITI (Principal, Interest, Insurance, and Taxes).

Back:  Annual Income/12=Monthly Income.  Monthly Income*Back Ratio=Your max debt payments.  This amount includes all your debt including your mortgage payment from the front ratio.

DTI ExamplesSo, for someone earning $50,000.00, he/she could qualify for the max mortgage payments shown in green.  Now, add the mortgage payment and all other debts you currently owe (car payments, credit cards, student loans, installment loans, child support payments, etc.).  This is a great place to start when considering your budget.

Now, let’s take a real world example:  Pat earns $50,000.00 annually.  Pat finds a home and wants to offer $100,000.00.  Pat goes to the bank and fills out a loan application.  The bank asks Pat for several documents to prove income and other necessary information plus pulls Pat’s credit report.  Now the bank knows all Pat’s debts.  Pat’s credit score is 780 (an excellent score).  Pat has a $200.00 car payment, and a total of $50 in monthly credit card payments. Pat has no other debts.  Pat has saved $25,000.00 for a down payment.  Based on all this information, the bank easily approved Pat for a mortgage loan.  Pat is offered a conventional loan at an interest rate of 3.92% for 30 years.

So, let’s figure Pat’s mortgage payment.  Home cost ($100,000.00)-Down payment ($20,000.00)=$80,000.00 Loan.  Pat’s loan($80,000.00)*Interest Rate (3.92% Compounded) = $378.25 (The P and I of PITI).  Now, we have to add in the cost of Taxes ($4,000/12=$333.33 per month) and Insurance ($800/12=$66.67 per month).  Pat’s total mortgage payment is $778.25 ($378.25+$66.67+$333.33).  Pat’s actual DTI is 19% ($778.25/$4,166.67).  Pat DTI is clearly lower than his max Front Ratio DTI.

Now, let’s check Pat’s Back Ratio.  Pat’s mortgage payment ($778.25) + car payment ($200.00) + credit card payments ($50.00) for a total monthly debt payment of $1,028.25.  Pat’s Back Ratio DTI is 25% ($1,028.25/$4,166.67).  Pat loves the new home ;-).

DTI is just one consideration when buying a new home.  More topics coming soon.