Everyone has that picture perfect home they want to buy, raise a family and create forever memories. But few people can afford their dream home at first, if ever. By prioritizing your needs and desires, you can shop for the right home that fits your financial picture. When it comes to mortgage rates in California: how can much can you really afford? It comes down to DTI established through a pre-approval process.
Getting Pre-Approved, Not Pre-Qualified
“Words smurds,” some will say. There isn’t a difference between pre-approval and pre-qualified. After all, when you spoke with the lender in the pre-qualification you gave him a full picture of your financial statement. The problem is you didn’t realize there were a few things on that credit report you weren’t aware of. Those few little things might affect your debt-to-income ratio or credit score just enough to change the interest rate you qualify for and possibly the amount you qualify for.
The problem with pre-qualification is the lender is giving you a ballpark idea; it’s a rough estimate. Credit reports aren’t required and the lender doesn’t have all the details to know exactly what you can afford. A pre-approval process looks at it all and is essentially the complete loan process less the desired home in escrow.
What is a Debt-to-Income Ratio
The Debt-to-Income Ratio, called a DTI by lenders trying to confuse you, looks at how much in monthly debt payments you have compared to your income. This is where the homebuyer meets his home in how much is affordable.
While everyone is concerned about credit, as they should be because it is a significant factor in qualifying for a loan in the first place, DTI is going to look at what your monthly obligations are and if you can take on more. Most first-time home buyers use a federally insured program such as an FHA or VA loan. These programs use different DTI ratios for eligibility purposes, so check with each lender to find a program best suited to your needs.
Don’t get confused when the lender uses two DTI numbers in a fashion similar to this, “28/36.” The first number, 28, refers to the maximum percentage your mortgage payment can be called the front-end DTI. The second number, 36, refers to the maximum all debt payments plus other debt payments called the back-end DTI. The 28/36 DTI numbers are used as a general rule of thumb among lenders and give you a good idea, meaning you can’t exceed the ratio.
Calculating Your Affordability
If DTI calculates your maximum payment, calculating DTI tells you your affordability. It’s a simple calculation that you can do – remember that even if you do it, you are just ballparking it.
DTI = Monthly Debt / Monthly Gross Income
For example, assume you have a $200 car payment, $100 student loan payment and pay $50 towards your credit cards every month as the minimum payment. You make these payments from the $2,200 you make every month.
- Front-end DTI = Mortgage Payment / Monthly Gross Income
- 36% = Mortgage Payment / $2,200
- $616 = Max Mortgage Payment
- Back-End DTI = (Monthly Debts + Max Mortgage) / Monthly Gross Income
- Back-End DTI = ($350 + $616) / $2,200
- Back-End DTI = 43%
In this scenario, you would either need to reduce other debt by paying (maybe paying off the car) to reduce overall DTI or reduce the max mortgage payment to meet maximum DTI ratios or speak with your lender about possible options.