Is there a secret score that determines how big of a home loan you can get?
Yes, and that’s what we’ll be diving into today.
Hopefully everyone knows about their credit score by now. You might not know the exact ins and out of how it gets calculated, but for the most part it is pretty straightforward. There are plently of resources to help you and I’ll link some in the description. Additionally, I’ll be doing a video all about credit and the various credit scores. Did you know you have at least 3, and some people have more?!
The score that I’m going to be talking about today isn’t going to be on any financial app you have, because the programs that calculate it are proprietary AI-powered systems that comb through hundreds of factors to label your financial stability when deciding whether you qualify for a mortgage. These programs are known as an AUS and the score I’m talking about is your DTI.
What is DTI? DTI, or the Debt-to-income ratio is simply your total monthly payments paid to debt servicing, divided by your total monthly income.
Why is this so important? It is important because taken alongside other factors like your total income, various liabilities, credit score, and so on, your DTI provides a valuable metric for banks to gauge how likely you are to make good on your mortgage payment.
Now if you have zero debt and one simple form of income with no investments or loans or credit cards of any kind, your DTI will be fairly simple to calculate. However if you recieve income from multiple sources write off income for tax deductions, have rolling credit card balances, student loans, and more, then your DTI becomes much more complex to calculate. For the vast majority of loans, an Automatic Uunderwriting System is used, so this calculation is a cinch.
Let’s briefly look at some of the ways that debt can be calculated. Often when people are trying to calculate their DTI they will give the loan officer the total debt balance. Now this is useful to see the total debt burden they have, but for the purposes of calculating a DTI ratio, that is not what is needed.
What we are interested in is how much money, every month is paid to debt. Now this debt can be calculated different way depending on what kind it is.
Take, for example, student loans. When your credit is pulled sometimes a monthly payoff amount is annotated. This is the minimum that is due and is usually a low amount like 17 or 35 dollars. However, if there is no amount or there is just a zero, the lender will have to use a percentage of the total amounts to calculate a monthly minimum. When using FHA or Freddie Mac, that percentage is 0.5%, but when using Fannie Mae the the number is 1%. That means if you have $50,000 in student loans, FHA and Freddie Mac will treat that debt as having a monthly payment of $250 but Fannie Mae would treat it double, at $500. If you don’t know these terms mean, don’t worry. I’ll cover them in a future video. These means that even though using Fannie Mae may result in lower closing costs, certain borrowers with high student debt may have to go with a program more favorable to their situation.
Another common situation is with installment loans. Installment loans are loans that are paid off in a set number of payments, like vehicle payments. Historically, when someone has 10 or less months on an installment loan, the loan underwriter doesn’t have to count it towards their overall monthly debt payments, but lately some underwriters may use their discretion and count installment loans unless there are only a few months left.
This is opposed to revolving credit lines such as credit cards. Credit cards are down as revolving credit because there isn’t a set time in the future when the line will be closed out. As long as the individual keeps paying their bill, the credit line will stay open. For this debt, the credit card minimum payment will be used to determine DTI.
Lastly, but probably most importantly, is the DTI will include your future mortgage payment including the loan principal, insurance, and insurance. HOA is also lumped into this along with a few other fees so it pays to pay attention to the final figure when seeing how much you can afford.
If all this seemed a big confusing, don’t worry too much about it. A knowledgable loan officer will be able to take care of a lot of the background calculations for you and let you know what you qualify for- and more importantly- how you can get to your goal by suggesting what debts to pay off so you get the biggest results for your valuable dollars!
If you already knew one of these tips, leave a comment and let me know! I’d love to see how knowledgable the community is!