Mortgage

Debt-To-Revenue Ratio, Taxes, and Insurance coverage: How Your DTI is Calculated

Does DTI include taxes and insurance?

Your debt-to-income ratio (DTI) is one of the key figures that lenders use to determine how much home you can afford.

DTI measures your monthly income against your current debt, including your mortgage, to find out how much you can afford for your budget.

Because property taxes and homeowner insurance are included in your mortgage payment, they also count towards your debt-to-income ratio. This means that tax and insurance rates will affect your loan amount.

Here's how to calculate the DTI with taxes and insurance and find out what you can really afford.

Check Your Budget For Home Buying (Jan 12, 2021)

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How is the DTI calculated?

Lenders want to be sure that you can pay back your mortgage debt. Therefore, they carefully examine some financial details, including your debt to income ratio (DTI).

The DTI is calculated by adding your monthly debt payments and dividing by your gross monthly income (before tax).

Some of the debts that count towards your DTI include:

Home loan payments (including principal, interest, taxes, and insurance) Credit Card DebtStudent LoansCar LoansPersonal LoansChild SupportAlimonyAll other monthly payments for debt, even if not listed on your credit report

This shows what percentage of your income is being taken from existing debt and what is the mortgage payment that you can reasonably afford in addition to your current obligations.

Note that non-indebted payments such as gas, electricity and cell phone bills do not count towards DTI.

Check Your Budget For Home Buying (Jan 12, 2021)

How taxes and insurance affect your DTI

"Property taxes and homeowner insurance are definitely part of calculating the debt-to-income ratio," said Denise Panza, a senior mortgage lender at Total Mortgage. "In fact, they're a big part of the equation."

Taxes and insurance are usually paid along with your mortgage loan and interest. Therefore, lenders add the monthly cost of taxes and insurance to your mortgage payment to determine what you can afford.

Britny Lawhorn, mortgage expert and publishing assistant at Finder, recommends that if you are planning on buying a home, consider how much your property taxes and homeowner insurance will cost and how both will affect your overall home buying budget

Because property taxes and insurance costs vary from homeowner to homeowner, some buyers are more affected than others.

"Also, consider whether you expect these costs to increase along with the cost of improving, repairing, and maintaining your home," she adds.

Property tax rates

Taxes on real estate can vary widely by state and county.

"The difference between, for example, a tax rate of 1 percent and 1.5 percent is enormous," says Tom Trott, branch manager of Embrace Home Loans.

“For example, if the estimated value of your home is $ 300,000, your property tax will be $ 3,000 or $ 4,500 based on a 1 percent or 1.5 percent tax rate. The monthly escrow you would pay for these taxes would be between $ 250 and $ 375. "

Trott explains, "If you were making $ 5,000 a month, your DTI rate would increase 2.5 percent just because of that tax rate."

Two types of insurance

When talking about taxes and insurance, understand that two different types of insurance are counted for your DTI.

"First, there is homeowner insurance that covers you in the event that your property is lost, such as due to fire, theft, injury, or other damage to your home," says Trott.

The second type is mortgage insurance.

“Mortgage insurance covers the financial institution that owns your loan. If you defaulted, the mortgage insurance pays your lender for the loss as a result of the default, ”says Trott.

Mortgage insurance is usually required if you are putting less than 20% on a home loan. This usually takes the form of Private Mortgage Insurance (PMI) for a traditional loan or Mortgage Insurance Premium (MIP) for an FHA loan.

The amount you pay depends on your loan type, down payment, and creditworthiness.

DTI calculation example

Let's say your gross monthly income (the amount you make before taxes and other deductions) is $ 7,000.

For example, let's say your total monthly debt payments total $ 2,500:

$ 1,500 – Estimated monthly mortgage payments ($ 1,150 for loan principal and interest, $ 50 for homeowner insurance and $ 300 for property taxes) $ 300 – Monthly car payments $ 300 – Monthly student loan payment $ 400 – Minimum payments for credit cards and other monthly debt obligations

Mortgage payment with principal and interest estimated using The Mortgage Reports mortgage calculator. Your monthly payment will depend on your interest rate, location, and a lot more.

To get your DTI, you would divide $ 2,500 by $ 7,000, which gives a rate of roughly 36%.

This is the same amount that most lenders will approve. Some even allow a debt to income ratio of up to 45% or 50%.

Note that in this example, the monthly mortgage payment includes property taxes and homeowner insurance premiums. HOA fees are also usually included if the property is part of a homeowners association.

If you pay less than 20% down payment, you will likely also need to pay private mortgage insurance (PMI) which would also be included in your DTI.

Other monthly housing costs such as utilities are not included.

The higher your property taxes, homeowner insurance, and mortgage insurance premiums, the less space you have in your budget for principal and interest payments.

This means that taxes and insurance can have a significant impact on the amount of credit a mortgage lender will approve you for.

Check Your Budget For Home Buying (Jan 12, 2021)

Front-end and back-end DTI

Lenders often calculate two separate debt-to-income ratios: front-end DTI and back-end DTI.

"The front-end quota is just your home-related debt," Trott says. "This includes your monthly mortgage-based payment of principal and interest, property taxes, monthly mortgage insurance if applicable, homeowner insurance, and homeowner or condominium associations, if applicable."

Trott explains that when property taxes and homeowner insurance are added up as an annual amount, that amount is divided by 12 to estimate the average monthly amount that would go towards the front-end ratio.

The back-end quota, on the other hand, includes housing costs plus monthly payments for all other outstanding debts, according to Panza.

"Those other outstanding debts could include credit cards, student loans, auto loans, child support, child support, and installment debt," she says.

What DTI rate do lenders want to see?

Lenders prefer a DTI ratio that is within an acceptable range or below a certain threshold.

"Lenders often prefer a DTI of 43 percent or less for conventional or FHA loans and 41 percent for USDA and VA loans," Lawhorn says.

"Some loan programs allow borrowers to exceed these limits if they meet certain qualification criteria."

In his experience, Trott has observed that lenders are flexible with some of these limits.

“Fannie Mae and Freddie Mac's back-end odds often need to be below 50 percent or even less if your creditworthiness isn't that high. FHA and VA loans can often be as high as 55 percent, depending on offsetting factors such as credit, discretion, and cash, ”he says. "USDA loans typically require a maximum of 29 percent for the front-end rate and 43 percent for the back-end rate."

New DTI rules offer more flexibility

Note that a new Qualified Mortgage (QM) rule has made lenders more flexible about debt requirements.

"In the past, lenders had to strictly adhere to the DTI limit of 43 percent," says Lawhorn.

“Under the new QM rule, lenders still have to rate a borrower's DTI, but they can take into account the types of borrower's debt. And they can take into account expected future income instead of sticking to a numerical calculation. "

How does DTI affect your mortgage?

As mentioned earlier, your DTI rate affects your ability to qualify for different types of loans – including conventional loans, FHA, VA, and USDA loans.

However, DTI is not the only criterion that lenders look closely at.

“Credit scores are also important because many programs have minimum credit score requirements. The amount that you can use towards your down payment is also important, ”says Trott.

To improve your chances of getting approved and getting the best mortgage loan interest rates, you are ready to do some homework.

“Work on improving your credit score. A score of 720 and above gives you a better rate, ”suggests Lawhorn.

“Also, try to save as much as you can so you can afford a higher down payment. And avoid making big purchases like a new car before applying for a mortgage loan. "

Taking out large debts or opening a new line of credit before applying for a home loan can affect your creditworthiness as well as your DTI, and can reduce the loan amount significantly.

Find your home purchase budget

You can estimate your budget for home purchases using today's mortgage rates and a mortgage calculator.

When you're ready to start looking for a home, you can get pre-approved by a mortgage lender. This gives you a verified budget and the clout you need to get a competitive listing on a home.

Are You Ready To See How Much House You Can Afford?

Check your new plan (January 12, 2021)

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