What is “DTI” and how does it influence how big my mortgage can be?
We’ve all done a bit of hypothetical house hunting before, right? You’re up late. You’re curious. You want to see if that dream house is on the market, just waiting for your mortgage. So you hop on your favorite listing site or you drive around neighborhoods ooh-ing and ahh-ing (or ew-ing) at different styles.
At this point, you know what you like and you know what you want, but when it comes to finding out how much you can afford? You’ve got no idea where to start.
Deep breath. That’s not a bad thing—it actually means you’re just like hundreds, if not thousands, of other like-minded future homeowners who are asking themselves the very same questions.
“Okay, but how much mortgage can I really qualify for?”
Glad you asked. Just out of curiosity, how’d you do in math class?
Kidding. Sort of. Turns out, there is a bit of math involved in figuring out how much money you might be able to borrow to finance your home purchase.
In our world, there’s this thing called the “29/41 rule” (or the 28/43 rule, or the 28/36 rule…honestly, jury’s still out on which one it is, but different loans may follow different rules). If your numbers exceed these percentages, the odds of you being approved for your mortgage decrease substantially.
Loosely speaking, this refers to two things:
- The first number represents the suggested gross (pre-tax and other deductions) monthly spending on your mortgage payment. It should take up no more than that number, as a percentage, of your gross monthly income. If you make $8,333 per month (or $100,000 per year) you shouldn’t spend more than roughly $2,400 on your mortgage payment.
- The second number refers to the gross monthly expenditure on debts—things like student loans, car payments, credit card payments, etc. Again, if you’re making $8,333 per month, your debt expenses shouldn’t be more than a little over $3,300. Note: This debt percentage includes your future mortgage payment.
These figures are determined by formulas. Not the fancy ones you see written on chalkboards, but relatively straightforward ones like the following, which is used to determine your DTI—or “debt-to-income” ratio.
How to calculate DTI
Installment Debt + Revolving Debt / Gross Monthly Income x 100
(Note: Disregard PEMDAS for this formula. Dear Aunt Sally has no control here.)
So, hypothetically, if you had monthly installment debts (things like credit cards) of $200 and monthly revolving debt payments (for car payments, mortgage payments, student loans, etc.) of $2,400, you’d have a total of $2,600 of monthly debts.
Now let’s say you made $100,000 per year, either as a single person or as a family. Divide that by 12 and you’d get a gross monthly income of about $8,333.
$2600 / $8333 = .031201248
Multiply that by 100, and you’d get 31.201248—or a little over 31%—which is below the suggested 36, 41, or 43% recommendation. Fortunately there are computers that do this math for you, so you shouldn’t ever have to worry about it.
Your DTI helps lenders figure out your ability to pay back your mortgage. The lower your DTI, the more room you have for a mortgage payment and other expenses. More room, more mortgage. More mortgage, more home. You see where this is going? DTI has a direct impact on how much money you’ll be allowed to borrow for your home purchase, and a higher DTI can limit how much you’ll be able to borrow.
No matter what, it’s important to remember that while DTI is one component of your mortgage application, it’s just a glimpse of where you’re at right now—not what life, and your financial situation, will be in the future. People get raises, cards get paid off, vehicles need replacing…situations change, for better or for worse.
So while you might be able to afford a certain amount per month, many experts suggest planning ahead as much as possible. This often means targeting a payment that’s less than what you can afford right now to leave room for what could pop up in the future.
One of the best ways to figure out how much mortgage you can afford is to obtain a pre-qualification. Before you get too excited (or too anxious), keep in mind that a pre-qualification is not a pre-approval. We’ve covered the difference extensively in the past, but here’s the gist:
- Pre-qualification: When you submit basic information to get a rough budget for your home purchase.
- Pre-approval: When a lender completes a full review of your information (credit score, income, assets, etc.) and extends a preliminary loan offer.
Once you obtain your pre-qualification number, run it through your personal budget and see if it’s something you can comfortably afford. Don’t forget to leave room for variables, however unknown they may be.
From there, the rest is up to you. Feeling confident? Connect with the experts at Cardinal Financial to request a free rate quote and start the journey toward homeownership today.
Target a payment that’s less than what you can afford right now to leave room for what could pop up in the future.