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An Introduction to the Debt-to-Income Ratio

Posted by Justin Havre on Monday, February 4th, 2019 at 10:32am.

Understanding the Debt-to-Income RatioApplying for a mortgage can be a big step for anyone, and while it’s very exciting, it can also be a little stressful. Many individuals spend a lot of effort making sure their credit score is good enough and that they are caught up on all of their bills, but there is another part of the approval process for a home loan that many don’t know about.

Referred to as the debt-to-income ratio, lenders look at how much debt someone has and compare it to their income and what their potential mortgage payment would look like. It’s an important figure to consider and can sometimes make the difference between getting the house of your dreams or not.

What Exactly Is DTI?

When lenders calculate your debt-to-income ratio, or DTI, they take a lot of numbers into consideration. Your DTI is actually composed of two different figures; one is referred to as the front-end and one is the back-end.

In simple terms, the front-end ratio is the cost of your housing divided by your monthly income before taxes. This number is attempting to generate an idea of how much of your paycheck would be taken up by your mortgage. Lenders typically like to see your front-end DTI below 28 percent.

The back-end DTI addresses your debt and aims to make sure you aren’t stretching yourself too thin with a mortgage payment. The sum of all of your debt plus your housing costs would be divided by your gross income. If this number is above 36 percent, you might not get the mortgage you were hoping for.

How Can A DTI Change?

If your lender determines that your DTI is too high, it doesn’t mean you can’t buy a home. In fact, there are several options available for modifying your DTI to bring it into an acceptable range. This can be addressed from a variety of perspectives, like raising your income or lowering your obligations.

Sometimes people choose to take on a second job just to boost their income enough to lower their DTI. This could be a potential short term option if you really want the Calgary house of your dreams, but make sure you’ll be able to keep up with expenses if you decide to quit.

Others try to work extra hours to pay down debt so that their back-end DTI is lower. If the problem is within the front-end DTI, it might mean that your budget needs to be scaled back a bit. Shopping for a lower priced home obviously results in a lower mortgage payment, and this will have a positive effect on the front-end DTI.

How A Higher Down Payment Can Make It Easier To Qualify For A Home When You Have High DTI

A high debt to income ratio can make it difficult to qualify for a mortgage that is enough to purchase the property one wants. Mortgage limits are calculated looking at an individual's debt to income ratio. If the ratio is high, it is determined that the individual is not able to afford as high of a mortgage payment than if the debt is low and the income is high.

One way individuals are able to afford a home that is more expensive than their debt to income ratio will allow them to borrow is to pay a higher down payment. When one is limited in the amount of money that can be borrowed with a mortgage, one way to afford a more expensive property is to cover the additional money with a down payment. The other way to qualify for a higher home mortgage is to either raise income, lower debt or do a combination of both.

When a higher down payment is put down on a property, the borrower doesn't have to qualify for mortgage insurance if the down payment is 20% of the purchase price or more. This can make a mortgage more affordable without the additional cost of the insurance and give a borrower the opportunity to qualify for a better mortgage rate.

Prepare Before Applying

It’s drilled into our heads from a young age, but it really is true that being responsible with credit has its rewards. Being really excited about purchasing a City Centre home doesn’t mean you have to eat ramen every day and keep the lights off all of the time. As long as both the front-end and back-end DTI ratios are within allowable limits, your application should proceed with no problem. Remember, if your ratios are too high, there are steps to take to bring these numbers to an acceptable range.

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