Understanding Key Terms: DTI, LTV, PMI, and MI Explained
If you are a first time home buyer, or even if you already own a home, understanding the terminology of a loan can be mind numbing! So many letters being thrown at you…PMI, MI, FHA, DTI, GFE, URLA, LTV! Of course, your loan officer will explain these terms as they come up, but it can be difficult to keep track of them all.
While every acronym is important, there are four that are especially important to understand; DTI, LTV, PMI, and MI before committing to a loan. Over the course of the month, I’ll be going over these terms. First, let’s start with the all important DTI.
DTI: Debt to Income Ratio
When you are getting pre-approved for a loan, or refinancing your current loan, your Debt to Income ratio (DTI) will be a determining factor. This ratio is the percentage of how much of your monthly income is committed to your monthly debts.
Bills such as your cell phone, internet, and gym memberships aren’t considered towards your “debt.” In the eyes of the bank who is approving your loan, the only debts they are concerned with are those that show up on your credit report. Common debts are car loans, student loans, mortgages, credit cards, child support, etc.
When calculating your income, the bank is looking for your gross monthly income, or the amount you earn BEFORE taxes. Other income will also include qualified child support, spousal support, rental, retirement, and disability.
Generally, banks will require that you have a DTI ratio no greater than 31% on the front end (not including the proposed mortgage payment) for an FHA loan. In considering a conventional loan, generally a DTI ratio no greater than 28% on the front end is accepted.
In order to calculate your DTI, you will need to divide your total monthly debts by your total gross monthly income.
Monthly Debt / Gross Monthly Income = Debt to Income Ratio
Scenario #1: FHA buyer looking to purchase their first home
Total Monthly Debt = $500 a month
– Car loan = $220
– Student loan = $130
– Credit Card payment = $150
Gross Monthly Income = $5000 a month
$500 / $5000 = 10% DTI
Scenario #2: Conventional buyer looking to purchase a 2nd home
Total Monthly Debt = $1700
– Mortgage = $1200
– Car loan = $450
– Credit Card payment = $50
Gross Monthly Income: $3800
$1700 / $3800 = 45% DTI
In scenario #1, the DTI is well under the maximum 31% allowed for an FHA loan. As a result, this particular borrower would generally meet the DTI requirement. In scenario #2, the borrower’s 45% DTI is too high, and therefore, will probably not meet the DTI requirement.
There are sometimes exceptions to these guidelines, and each lender will have their own requirements. Therefore, it is important that you discuss with your lender about their specific guidelines. Do not be afraid to ask your loan professional questions, that is what we are here for! Asking questions, and fully understanding the terms of your loan is crucial to making the right decision for you.
If you have questions regarding an FHA loan, or would like to know how much you are pre-approved for, visit my website at www.AlissaAlvarez.com