When shopping for a home make sure to get approved for the maximum amount you can qualify for. As a buyer you’ll want to know how much home you can afford and the only way to do that is to know what the maximum amount is that you can qualify for. You may not necessarily want or need to spend the maximum of what you qualify for but you want the option to spend more if you need to.
One thing a lender will check when beginning the loan approval process is to determine your debt-to-income ratios. This fancy name is basically your total monthly income before taxes divided by your total monthly bills. You’ll get a percentage and that percentage is your DTI or debt-to-income ratio.
How Much Home Can You Afford?
DTI’s are often broken down into two sections, a front end and back end. Front end ratios are housing costs like pricinipal, taxes, insurance, HOA fees, etc. Back end ratios is your personal debt like credit cards, car payments, personal loans, etc. When you see a ration on your loan application that looks something like this 35/42 then you know the first number is your front end and the seconds would be your back end ratios.
While there is no set rule for the perfect DTI, a general rule of thumb is 33/38. These numbers come from the facts that a typical borrower/buyer will spend about 1/3 or 33% of their monthly income on housing costs, i.e. the “33”. When adding the borrowers additional bills not directly related to housing costs like the personal items we discussed above the number should be no more than 38%, i.e. the “38”.
Again, the DTI has no set rule and will vary based on lending guidelines, while the above ratio is the best overall average to shoot for, programs like FHA have a standard of 29/41 and VA has no front end but requests buyers not exceed a 41 backend. Items like interest rates, credit worthiness, down payment and other similar circumstances will play a part in how much weight a lender will put on the DTI. For instance, if you make a larger down payment you may notice if you have a higher DTI that you still get approved. It’s best to have a conversation with your lender beforehand to discuss these items and formulate a game plan that will best suit you and your needs.