When you shop for a mortgage or other loan, one of the key factors a lender takes into consideration before granting approval is your debt-to-income ratio. This is the ratio between how much you owe each month ( the total monthly debt payments) and how much you earn (gross). This ratio calculates the percentage of debt you are carrying in relation to how much money you are making and gives lenders a good indication of how much additional debt you´ll be able to handle. Each lender has guidelines on how much the Debt to income ratio (DTI) can be. The usually DTI ratio is about 28% - 36%. Though there are lenders that allow up to 50% debt to income ratio. But the higher the ratio, the higher the rate usually. There are exceptions. FHA allows up to 41%. If you have good assets, good reserves, (money in retirement accounts, mutual funds, stocks, bank accounts) and good time on your job the lender may give you a great rate and an exception to the rule.
What the lender does is pull a credit report. They take every debt that shows up on the credit report and add them together. What the lender is adding up is the monthly payment that shows on the credit report not the balance. So your car payment, your credit car payments, your student loan payments, your boat loan payments, your four wheeler payment. They all count toward your debt. Then the lender calculates your new Wayne County home payment, or your new Oakland county home payment, or your new Livingston county home payment. They include the taxes and the insurance. So your debt is all your monthly payments plus your proposed house payment with taxes and insurance.
When you are buying that Livonia home, or Novi home or what ever city you are buying in the lender will ask you for your last 2 years w-2's or last 2 years tax returns. And the lender will ask for a month's worth of pay stubs. The lender then figures out what your average monthly gross income is from your w-2's and paystubs. They can tell if your income is rising, steady, or declining (from cutback on overtime). If there is a large raise in income they may ask for an explanation or a letter from your employer on the raise. The lender will use the new pay increase as their figure for your monthly gross income. Or if you were on sick leave or helping care for a family member and your pay is down last year, the lender may ask for a letter from your employer. Just because you are supposed to average $52,000 a year and your w-2's show $45,000 for the last two years because you take time off. The lender is going to use the $45,000 average. The lender even figures out from the year to date on your paystub what your monthly average is for this year.
There is no fooling the bank. They even verify the w-2's and the paystubs you give them. They do a verification of employment and income with your employer. The lender even checks your tax returns that you filed with the government against the income paperwork you gave them. So now the lender has figured out what your average monthly gross income is.
So the formula is all your monthly debt payments added to your proposed house payment with taxes and insurance divided by your gross monthly income.
Let's say your new Livonia Home or Oakland County Home or whatever home you buy is going to cost you $1300 a month with taxes and insurance. You have another $500 a month in car payments, and Sears credity card. Your total debt payment per month is $1800. You gross $5000 a month. You divide the $1800 by the $6000 and your debt to income ration (dti) is 36%.
That is what DTI is. For information on credit scores, more credit scores info, closing costs, pmi
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