by footloose » Wed Feb 02, 2011 04:41:35 PM
When you begin to negotiate or renegotiate a mortgage with a lender, there are several tools that a lender will use before a mortgage application is approved or declined. In addition to the usual Credit Report and Credit Score, the lender will perform a calculation known as a Debt-to-Income Ratio. The purpose of this calculation is to determine if you have enough income to service the mortgage.
A debt-to-income ratio ( often referred to as DTI ) is defined as the percentage of a consumer's monthly gross income that goes toward paying debts. Strictly speaking, DTI's cover more than just debts. They cover any monthly payment that you are committed to pay, such as rent, mortgage payments, condo fees, insurance, etc. More about these costs later.
There are two main kinds of DTI and they are expressed as a notation such as x / y for example 28 / 36
1. The first DTI, commonly known as the FRONT END RATIO indicates the percentage of gross income that goes towards housing costs, which for renters is the rent amount and for homeowners is the PITI ( mortgage principal and interest, property taxes and mortgage insurance premium { if applicable } ) together with condo fees, property insurance premium and homeowner association dues { if applicable }.
2. The second DTI, commonly known as the BACK END RATIO indicates the percentage of gross income that goes towards paying off recurring debt payments, including those included in the first DTI and other debts such as total minimum payments on all credit cards, car loan or car lease payments, personal loan payments, line of credit payments, cell phone payments, student loan payments, monthly payments ordered by the courts and alimony and child support payments.
All major Canadian banks require a DTI of 28 / 36. This is a standard within the banking industry. Some private lenders may grant a mortgage with a slightly higher ratio, however, they will compensate by charging a higher rate of interest.
EXAMPLE
In order to qualify for a mortgage for which the lender requires a debt-to-income ratio of 28 / 36
Yearly Gross Income = $60,000 / Divided by 12 = $5,000 per month
$5,000 Monthly Income x .28 = $1,400 allowed for housing expense
$5,000 Monthly Income x .36 = $1,800 allowed for housing expense plus recurring debt.
I hope that I have outlined how lenders evaluate your financial position in determining whether to issue you a mortgage.
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