Debt to Income: Your Income and Credit Report Matter

In recent years, new federal laws have added a new qualification guideline to the mortgage industry called Ability to Repay. To avoid foreclosures like those that occurred during the housing bubble burst, this guideline assures borrowers can reasonably repay all of their monthly liabilities. This ability is determined based on your Debt to Income Ratio (also known as DTI). DTI looks at how much you have going out to debts versus your income. DTI includes liabilities such as your mortgage, escrow, credit cards, auto loans, student loans, and installment debts. Though some programs allow for higher DTI, most conventional loans require Debt to Income Ratios below 45%, meaning no more than 45% of your income can be going out to designated debts.

Income is pretty self-explanatory. The important thing to know is that when a Loan Advisor is looking at DTI, they consider gross income rather than net income. There are two documents we usually gather to verify these amounts: Paystubs and W2s. Paystubs can show us salary, hourly rate, or year-to-date pay, all of which can be used to calculate your DTI. W2s (or less commonly 1099s) show us your income which can be found in Box 1 of all W2s. To make math easier for us, DTI is calculated on a monthly basis, so take your total gross income for the year and divide it by 12.

So how do we determine your debts? The most accurate way to take debts and liabilities into consideration is a credit report. That—along with your credit scores—is why it’s so important to have your credit pulled up first. It allows loan advisors to see the balance left on the liability as well as your monthly payment. The monthly payment for each debt is ultimately what is used to find DTI.

Let’s break down some examples to see how this works in practice:

• Yearly Income: $54,000
• Monthly Income: $4,500
• Monthly Liabilities: $1,450
  • Mortgage with escrow: $950
  • Auto loan: $350
  • Credit Card: $150
• DTI: 1,450/4,500=32%

Based on this example, you’ll easily qualify based on DTI as you’re well below 45%

But let’s look at the same situation, but with two auto loans:

• Monthly Liabilities: $2,200
  • Mortgage with escrow: $950
  • Auto loan: $750
  • Auto loan: $350
  • Credit Card: $150
• DTI: 2,250/4,500=49%

In this case, your DTI is over 45% meaning you would not qualify for the loan. But all is not lost! You can get around this by using the equity in your home to pay off the auto loans and/or credit cards or by taking out a longer term mortgage to get lower monthly payments. Not only does this qualify you for a refinance, but it will also lower your monthly outlay!

DTI is just one part of getting you qualified for a mortgage, but it’s the reason Loan Advisors ask about income and credit. Without them, we’re looking at an incomplete picture that keep us from being able to help you as best as possible.

Written by: Leah Spring, Loan Advisor at Royal United Mortgage LLC
Published: 3/24/2016