What are Debt-to-Income Ratios?
When lenders assess income to determine how much you will qualify for, they look at your “debt-to-income” ratio (DTI), which compares your total monthly liabilities (including the proposed housing payment) with your monthly gross income.
There are several loan programs with different debt-to-income ratio thresholds, but the most common is 49% for conventional financing, 56% for FHA financing, and 43% for most jumbo loans.
The housing payment includes all costs related to the home, including principal and interest, taxes and insurance, and mortgage insurance if the down payment is less than 20%.
What is Household Income?
Lenders use “household income” to determine the denominator of the DTI ratio. Any borrowers on the loan will be able to have their income considered for qualification. In general, any salary income, hourly wages, pension income, and social security income can be considered. Lenders need to demonstrate a 2-year history of employment for any borrowers on the loan. If a borrower does not have a 2-year history at their current job, education can supplement the history.
In order to use bonus or commission income, borrowers need to have a 2-year history of receipt. The lender will reach out to the employer to complete a “verification of employment” to confirm the annual figures.
For self-employed borrowers, lenders will need 2-years of tax returns to calculate the income. Lenders must start with the “net income” figure and can add back certain expenses such as depreciation. Oftentimes if self-employed borrowers write off a lot of expenses on taxes, they will qualify for less than they expected based on their gross receipts.
How to Calculate Household Income?
Review your paystubs to confirm your pay period (weekly, biweekly, bimonthly, monthly, etc).
- For weekly paystubs, take the gross income x 52 weeks, then divide by 12 months to get your monthly income.
- For bi-weekly paystubs, take the gross income x 26, then divide by 12 months to get your monthly income.
- For bi-monthly paystubs, multiply your gross income by 2 to get your monthly income.
How to Calculate Debt-to-Income Ratio?
Use a mortgage calculator to estimate the monthly payment for a house you’re considering. For example, a $750K house with a 10% down payment, a 5.5% rate, 1.25% in taxes, $157 per month in mortgage insurance, and $100 a month in homeowners’ insurance would have a monthly payment of ~$4,871.22.
Once you have the estimated mortgage payment, add in any other monthly liabilities you have, such as a car payment, student loan payment, minimum credit card payment, etc.
If you have a $350 car payment and $275 student loan payment and no credit card payments, your additional liabilities total $625.
The total monthly debt would be $5,496.
Compare the monthly debt with the monthly household income. For example, if you earn $4,000 bi-weekly, you’ll take $5,000 x 26 / 12 months = $10,833 per month.
The Debt-to-Income ratio is the total debt / total income = $5,496/$10,833 = 50.73%
In this example, the debt-to-income ratio is a little bit above the threshold allowed for conventional financing, so the clients could look at several options to get a loan, including looking at FHA financing, increasing the down payment, or paying off a monthly liability.
How much income do I need to buy a home?
Income requirements depend on the price range you’re looking at, your down payment, the interest rate, and other factors.
Here are some general estimates:
- To afford a $500K home with a 5% down payment ($475K Loan Amount), you need to make at least $85K.
- To afford a $750K home with a 10% down payment ($712.5K Loan Amount), you need to make at least $125K.
- To afford a $1M home with a 20% down payment ($800K Loan Amount), you need to make at least $140K.
Assumptions: conservative 5.5% interest rate, no additional monthly debts, 740 credit score for mortgage insurance calculations
What kind of salary do you need to buy a home in California?
With a $100K salary and no monthly debts, you can afford a house up to $720K, assuming a 20% down payment, up to $640K with 10% down, and up to $600K with 5% down.
What house can you afford if you have a $500/month car payment?
If you have monthly debts, such as a car payment, student loans, credit card balances, the monthly payment is included in the debt-to-income ratio and lowers the amount you can qualify for on a new house.
For example, if you have a $500 monthly car payment and a $100K salary, you’d be able to afford up to $630K with 20% down, $560K with 10% down, and up to $525K with a 5% down payment.
Can I get a second job to supplement my income to buy a house?
Federal lending guidelines require that lenders can only use one source of income to qualify for a mortgage unless a borrower has a 2-year history of consistently earning income from two sources. This means that getting a part-time job before applying for a mortgage will not help to qualify for a higher purchase price.
What can you do to qualify for a more expensive home in California?
There are several ways to lower the debt-to-income ratio to qualify for a more expensive house.
- Pay off any recurring monthly debts. For example, student loans, car loans, and credit cards can be paid off to qualify. Paying off debt does much more to increase the purchase price than using the same amount to raise the down payment.
- Add a co-borrower. A co-borrower can be added to a loan to bolster the monthly income. Ideally, the co-borrower would have a strong credit score and few monthly debts, as these must be counted in the DTI ratio.
- Increase the down payment. If there are no monthly debts to pay off, raising the down payment is another option to decrease the DTI. If you are below a threshold of 5%, 10% or 15%, raising up to the next threshold will help lower the loan amount and lower the mortgage insurance factor, which also reduces the DTI.
- Choose a single-payment mortgage insurance. Oftentimes, mortgage insurance can be several hundred dollars a month, depending on the credit score and the “loan to value” ratio. By paying the mortgage insurance upfront, you will lower the monthly housing payment and the DTI.
- Apply for a promotion or raise. If you have a promotion, raise, or job change, lenders can often look at the new
Interested in learning more about what mortgage amount you can qualify for or how to get started? Talking with a JVM Mortgage Expert is the first step in buying a home – we will gladly walk you through the home loan process and getting pre-approved.
