Mastering terminology, acronyms and abbreviations in the mortgage world can be a bit overwhelming. But understanding basic mortgage lingo is important to help you make informed, confident decisions throughout the lending process.
Let’s take a closer look at two of the terms you’ll definitely hear: Debt / Income (DTI) and Loan / Value (LTV).
Your DTI is a way for lenders to measure your ability to manage your monthly mortgage payments.
Bryan Clark, senior vice president of mortgage banking at Dart Bank, says two different DTI ratios are factored into the underwriting process.
“The initial ratio compares your total housing expenses to your monthly income, and the final ratio is your monthly debt payments to your gross monthly income,” he said. “While lenders look at the two digits, when you hear the term DTI, it usually refers to the primary number. “
As Clark mentioned, to calculate your back-end DTI, your monthly debt payments are added together and the sum is divided by your gross monthly income, which is the amount of money you earn before taxes and other deductions.
The Consumer Financial Protection Bureau (CFPB) gives the following example:
If you pay $ 1,500 per month for your mortgage and an additional $ 100 per month for a car loan and $ 400 per month for the rest of your debt, your monthly debt payments are $ 2,000 ($ 1,500 + 100 $ + $ 400 = $ 2,000). If your gross monthly income is $ 6,000, then your debt to income ratio is 33% ($ 2,000 / $ 6,000 = 33%).
The lower the DTI ratio, the more attractive you are as a borrower. This is because homebuyers with higher ratios – those who have more debt to their income – are generally seen as more likely to have difficulty making their mortgage payments.
While there are many “preferred” or “required” numbers circulating, the DTI is only one factor in the subscription process. Clark says the allowed ratio can vary depending on the lender and the loan program, and it also depends on the rest of the buyer’s financial situation.
“Someone with a larger down payment or a great credit score can be approved with a higher DTI,” he said. “For example, in the old days your front-end ratio couldn’t exceed 36%, but that’s not necessarily true anymore. I’ve seen initial ratios much higher than that get approved, and I’ve seen borrowers with much lower ratios turned down. The decisions are specific to each borrower.
There are basically two ways to lower your DTI: reduce your monthly debt and / or increase your gross monthly income. Using the numbers mentioned above, if the amount of debt is reduced from $ 2,000 to $ 1,500, the DTI would decrease from 33% to 25%. If the debt stays the same, but income increases to $ 8,000, the DTI will drop again to 25%.
Loan to value ratio
The LTV ratio is another loan risk assessment that financial institutions look at before approving a mortgage. This ratio compares your loan amount with the appraised value of the property. The higher your down payment, the lower your LTV ratio.
For example, if you buy a house for its appraised value of $ 100,000 and put in a down payment of $ 10,000, you will borrow $ 90,000. This results in an LTV ratio of 90 percent (90,000 / 100,000 = 90 percent).
LTV is a determining factor in buying a home, refinancing an outstanding mortgage, or borrowing against the equity in a property. As a general rule, the higher the LTV ratio, the more risky the borrower appears to the lender. A higher LTV does not necessarily exclude a borrower from being approved, but the interest rate may be higher than it would be for borrowers with a lower number. And, if your LTV ratio is over 80%, you will likely need to purchase private mortgage insurance (PMI).
Again, Clark says this ratio is another piece of the financial puzzle and he encourages potential borrowers to speak with a professional local lender before making any assumptions about their ability to qualify.
“Sometimes people underestimate what they can afford, and with rates so low right now, it can open up opportunities for new buyers,” he said. “Even if you’re not ready to buy now, consider setting up a consultation with a lender who will review your financial profile and provide you with suggestions on how to improve your position for a future purchase. “
For a list of reputable local lenders, visit the Greater Lansing Association of REALTORS® website at www.lansing-realestate.com.