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Debt to Income Ratio – DTI

Debt to income (DTI) ratio is a tool used by mortgage lenders to estimate the amount that a borrower can afford to pay. You can easily calculate your DTI at home or online before you fill out a mortgage application. Your debt to income ratio usually reflects your gross income which is your earnings before taxes. Also, debt to income ratio only includes fixed monthly payments that would appear on a credit report. The lower your DTI, the better off you are in the eyes of the lender. There are two types of debt ratios to consider:

  1. Front Ratio. The front ratio, also called the “housing ratio,” is your total monthly house payment, plus PMI, insurance and any other fees divided by your monthly income. If you had a monthly mortgage payment of $1500 and an income of $6000, then your ratio would be 25%.
  2. Back Ratio. The total debt ratio, known as the back ratio, is derived from the total monthly house payment, plus all other debts divided by your monthly income. Continuing with the previous example, if your car payments add up to $400 and your credit card payments are $200, you would add that sum to the housing payment ($1,500) to get $2,100. Divide $2,100 by your monthly income $6,000 to get a back ratio of 35%. In this example, the ratios would be 25/38.

DTI When Buying a House

Knowing your DTI can be very helpful, in fact, it may be just as useful as knowing your credit score when it comes to applying for a home loan. Comparing your expenses and monthly financial obligations with your earnings can give you and the lender a clear cut picture of what you can afford to borrow. The lenders want to see low debt to income ratios, as studies have shown that the lower the DTI, the less trouble borrowers had with paying back their mortgages. There are two ways to lower your DTI, by increasing gross monthly income and/or decreasing monthly debt.

There are many costs included when calculating your DTI, including:

  • Housing costs
  • Monthly credit card payments
  • Personal loans
  • Child support or alimony payments
  • Car loan payments
  • Home equity loan payments
  • Student loan debt

Benefits of an Adjustable Rate Mortgage

  • Lower monthly payments. The monthly payments on ARM home loans are typically lower than on a fixed rate mortgage.
  • Enjoy falling interest rates. If interest rates fall, so do your payments.
  • Borrowers who plan on relocating enjoy lower payments. This is a great choice if you plan on moving before your loan adjusts or you have to move often for work.
  • Making extra payments. If you plan on paying the loan off faster with extra payments, you might as well take advantage of the ARM’s lower interest rate.

Risks of an ARM Mortgage

There are some risks involved when taking out an adjustable rate mortgage. Fixed rate loans are usually safer investments in comparison, especially when interest rates are low. The payments on an adjustable rate mortgage can change dramatically over just a few years. If rates go up fast, a 3.5% ARM could easily jump to a 6% loan in 4 years.

If you play your cards right, the first adjustment will usually be the worst, since caps on annual payments won’t apply. ARM’s can be confusing, especially since lenders can choose their own indexes, caps and margins. Despite the risks, there are several advantages to adjustable rate mortgage loans.

Home Loan Margin Amount

The fully indexed rate is the rate by which your payment amount is determined. This number is derived from a mortgage loan’s index and margin added together. The United States Treasury and similar bodies help form a common index. When you apply for a mortgage, you may negotiate your margin rate with the lender.

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