Mortgage Ratios: It’s Not as Difficult as You Think
- August 17, 2019
When you apply for a mortgage, lenders look at more than your credit score. They also need to know your mortgage ratios – your debt-to-income (DTI) and loan-to-value ratios (LTV). Lenders use this information to determine your eligibility for a loan before even knowing your name or anything else about you. Here’s how it works.
Lenders gauge your ability to secure a mortgage on several comparisons. They compare your income to your debts and your loan amount to the home’s value. These numbers tell lenders a lot about your ability to afford a loan. Lenders use these ratios plus your credit score to determine your eligibility for a loan. Each loan program has different requirements or maximum DTIs and LTVs they allow. You can create an account and visit your dashboard for an interactive way to learn about these ratios and how they apply to your situation.
The Importance of Debt-to-Income Ratios
Lenders look at your debt-to-income ratios in two ways – the housing payment to income ratio (PTI) and the total debt to income ratio (DTI). You may also hear them called front-end and back-end DTI ratios; the terms are used interchangeably.
Before we get into the specifics, you should figure out your gross monthly income or your income before taxes. You’ll use this number for both the PTI and DTI. For example, if you make $75,000 per year, your gross monthly income is $6,250 ($75,000 ÷ 12 = $6,250). You’ll need this figure as you work out your own numbers.
The PTI ratio compares your gross monthly income to the projected housing payment. Your housing payment consists of:
- Mortgage payment
- Real estate taxes
- Homeowners insurance
- Mortgage insurance (PMI, if applicable)
- Homeowners association fee (if applicable)
Here’s an example:
|Real estate taxes||$200|
The total mortgage payment equals $1,500. If your gross monthly income is $6,250, you would figure your PTI as:
$1,500 (total mortgage payment) ÷$6,250 (gross monthly income) = 24% PTI
Once you know your PTI ratio, you can compare it to the maximum PTI allowed for each loan program:
|Conventional loans (see current mortgage rates)||28%|
|FHA loans (see current mortgage rates)||31%|
This information can help you determine if you meet the guidelines of any of the popular loan programs available today. Remember, the lower your PTI, the better your chances of getting a loan approval.
Unlike the PTI ratio which compares gross monthly income to the projected housing payment, the DTI ratio compares all of your monthly debts to your gross monthly income. All of your monthly debts include things like car loans, student loans, credit cards, and installment loan payments. Any debt that shows up on your credit report is a part of the back-end number, as well as any unreported debt, such as child support or alimony. Lenders use the minimum required payment to calculate your DTI along with the projected mortgage payment.
If your credit cards or a loan don’t have a minimum payment reporting on the credit report, it’s to your benefit to provide proof of the minimum payment with your latest statement. Without proof, lenders often use a large percentage of the balance as the minimum payment. This can make your total DTI higher than necessary.
Here’s an example:
|Credit card minimum payment||$65|
|Credit card minimum payment||$75|
|Student loan payment||$200|
|Projected mortgage payment||$1,500|
Your back-end ratio would be:
$2,040 (total monthly debts) ÷ $6,250 (gross monthly income) = 33% total debt ratio
Once you know your total back-end debt ratio, you can compare it to the maximum back-end DTI allowed for each loan program:
|Conventional loans (see current mortgage rates)||36%|
|FHA loans (see current mortgage rates)||43%|
|VA loans (see current mortgage rates)||41%|
As a rule, mortgage lenders shouldn’t allow DTIs higher than 43 percent. This is the Qualified Mortgage Rule guideline – a rule that came about after the housing crisis. The rule keeps lenders accountable, ensuring that each borrower can afford the mortgage they take.
Lenders also care about how much money you have invested in the home. In other words, what’s the ratio of your home’s value to the amount you borrow? Lenders like to see some ‘skin in the game,’ or your own money invested in a down payment. With your own money invested in the home, you are more likely to do what’s necessary to make your mortgage payments on time. On the other hand, if you borrow 100% of the home’s purchase price, you don’t have as much incentive to make the mortgage payments on time, which puts the lender at risk of you not paying. Borrowing too much also puts you at risk for being ‘upside down’ on the loan, or owing more than the value of the home. Today’s home values fluctuate often and with little equity in the home, it’s easy to find yourself owing more than the home is worth.
You can figure your LTV with the following calculation:
Total loan amount ÷ Current home value = Loan-to-value ratio (LTV)
Many people assume you need a 20 percent down payment to get a home, but that’s not the case today. We work with lenders that allow much smaller down payments and some even offer programs with no down payment requirements.
Before you make a decision, though, you should know how your down payment (or lack thereof) affects your mortgage. First, let’s look at the obvious – the more money you put down on a home, the less you have to borrow. This makes your mortgage payment lower, but that’s not it.
The more money you invest in a home, the less risk the lender takes. Often a lower risk means a lower interest rate or fewer fees. Lenders often base the amount they charge you to borrow the money on your risk of default.
Making a down payment also gives you equity in the home. Borrowers with equity have ‘emergency savings.’ While home equity isn’t liquid, you can refinance your mortgage should you need to get the equity out and use it for something else.
Your LTV ratios also determine the amount of mortgage insurance (MI or PMI) that you must pay. The less money you put down on the home (the more you borrow), the higher the insurance premiums become. This adds an additional expense to your monthly mortgage payment, which can last for many years.
Get the Right Mortgage Based on Your Debt Ratios and LTV
Knowing your mortgage ratios can help you determine which loan program is right for you. Our lenders base your eligibility for a loan on the numbers themselves. Looking at your PTI and DTI ratios, as well as the LTV, lenders can tell your ability to repay a mortgage. In a perfect world, borrowers have 28/36 debt ratios and an 80 percent LTV, but we work with lenders that offer loans for different types of borrowers, helping many people become homeowners today. Having a strong understanding of what your personal ratios are will give you confidence and leverage in your mortgage shopping experience. You can use our application and dashboard to start figuring this out.