With the U.S. currently in the middle of a student loan debt crisis, it makes sense to be concerned about how your own existing debt will impact your ability to buy a house. According to debt.org, the average student loan debt for 2016 college graduates was $37,172.
You need to factor in your existing debt when determining your target price range for purchasing a home because it will affect the kind of mortgage you qualify for. But how exactly does your debt impact your mortgage loan options? Here we’ll cover everything you need to know about your debt to income ratio and how it impacts your home buying experience.
What is your DTI and how does it affect your mortgage?
Your debt to income ratio, or DTI, is one of the most important metrics to consider after your credit score. It’s the primary tool that lenders use when they’re considering your loan application.
Your DTI is the percentage of your income you need to set aside every month to pay off your debt. When calculating your DTI, your lender will divide your monthly debt obligations by your gross income. You want the lowest DTI possible because this number doesn’t take into account your utilities, transportation costs, health insurance, food, taxes, or childcare costs. A low DTI ensures you’ll not only get a good mortgage rate but also that you’ll be able to pay off your debts while living comfortably.
There are two types of DTI: front-end DTI and back-end DTI. Front-end DTI includes mortgage payments, insurance property tax, and homeowner costs. Back-end DTI includes other types of debt such as car loans, student loan debt, and credit card debt. Lenders take both DTIs into account when you file an application.
Your DTI will also be compared to your credit score. Applicants with credit scores under 500 are generally ineligible for FHA loans. But sometimes the FHA will make allowances for applicants if they meet requirements.
What’s the best DTI to have?
Your DTI is one of the reasons why it’s so important to get your credit in order when you’re looking to buy a house. To get approved for a conventional mortgage, it’s best to have a back-end DTI of less than 43%. With excellent credit, you could be eligible for a conventional mortgage with a back-end DTI of 50%.
However, even with a DTI of less than 43%, it’s important to keep in mind that the mortgage loan options available to you might not be ideal for your situation. Make sure to do the math so you don’t overcommit yourself to monthly mortgage payments you can’t afford. You know your household budget better than anyone else.