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When buying a home, why is the DTI so important?

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The DTI is the acronym for “Debt To Income” and it is the ratio between your monthly income and your monthly liabilities. With liabilities we refer to all those credit debts with which you have a payment obligation such as credit cards, personal or student loans, lines of credit, financing or car lease, among others. Payments for water, electricity, telephone service, etc., are not considered a credit obligation and are therefore not taken into consideration for the analysis.

So, how it is calculated? When buying a home, the bank calculates your DTI dividing your monthly income by your total monthly liabilities. In this calculation it is a common mistake to assume that the outstanding balance on your credit cards is the amount to be taken, but the correct amount will be the minimum monthly payment required by the credit card bank.

In a Conventional Loan, this ratio (DTI) cannot exceed 50% and in an FHA it cannot exceed 55%. Within this percentage you must include the monthly payment of your mortgage.

For example, if your monthly income is $ 4,000 and you are being qualified for a conventional loan, the sum of all your monthly liabilities plus the monthly payment that you will have for the mortgage loan cannot exceed $ 2,000, which corresponds to 50% of $ 4,000. In an FHA Loan the same sum could not exceed 55% which would be $ 2,200 for all your debts including the housing payment and no more than 45% (or $1,800) per month for your mortgage loan. For that reason you will see that the DTI for FHA is 45%/55%, that means a maximum of 45% for housing payment and a maximum of 55% for all your liabilities (including the housing payment).

Let’s take another example: A couple is making $10,000 a month, they have a lease car of $350$/Month, another one of $450/Month and the sum of their total minimum monthly payments in credit cards is $120/Month ($60 Credit Card 1 + $50 Credit Card 2 + $10 Credit Card 3). So, they have a total of $920/Month in liabilities.

For a Conventional Loan, the Max DTI is 50% that in this example is $5,000 ($10,000/2) so for the mortgage loan, we can go up to $4,080 ($5,000 – 920) in a monthly payment.

So, why is the DTI so important? … It doesn’t matter if you have an excellent credit score or a lot of money in reserves, if in your DTI the bank does not have enough room for your mortgage, you will not qualify for a home loan.

What can you do? You can’t change your monthly income but you can reduce your monthly liabilities! so, pay you credit cards if needed to have more room for the mortgage, or apply with a co-borrower to have more monthly income.

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