Perhaps the most frequently asked question by many is, “does my debt-to-income ratio affect my credit score?”
Well, the debt-to-income ratio does not directly impact your credit score. Your credit utilization ratio determines your credit score. The credit utilization ratio is often associated with the debt-to-income ratio, but it is different. Here’s why:
Your income is not reported to credit agencies. However, your debt is directly tied to several criteria that affect your credit scores, including your credit utilization ratio. A high DTI ratio only implies that you struggle with debts. But, when you miss your debt obligations, you are most likely to have a bad credit score.
PRO TIP: Having a healthy and manageable debt-to-income ratio is as important as having a good credit score.
Mortgages and Debt-to-Income Ratio
When applying for a mortgage, your debt-to-income will always be a critical determining factor for the approval process.
Different mortgage lenders have different DTI ratio requirements and qualifications. Understanding your debt-to-income ratio can help you decide which lender best suits you. Plus, you get to save yourself the hustle of getting out of debt due to the wrong choices.
However, you need to understand the terms related to mortgages and debt-to-income ratios: front-end and back-end ratios. Before choosing to provide a mortgage, lenders frequently divide the information that constitutes a debt-to-income ratio into different categories (front-end and back-end ratios).
Front-end Ratio
The front-end ratio is the percentage of income devoted to paying the housing costs of the mortgage. It is calculated by adding the mortgage payment, homeowner’s insurance and association fees, and real estate fees and dividing the sum by the monthly gross income.
Lenders use the front-end and back-end ratios to calculate how much to loan and how much interest to charge. High front-end ratios are riskier for lenders and are more likely to attract a high-interest rate.
Back-end Ratio
Back-end ratios are synonymous with debt-to-income ratios. They include all mortgage debt and continuous monthly commitments like credit cards, vehicle loans, college loans, child support payments, etc.
Unconventional Mortgages
An unconventional mortgage is supported by a government agency such as the Federal Housing Association or Veterans Association. When reviewing your loan application and evaluating your DTI ratios, lenders follow the Federal Housing Association’s guidelines.
According to the guidelines, mortgages are granted to those with a maximum front-end DTI ratio(percentage of income devoted to housing costs) of 31% or a maximum back-end DTI ratio( of 43%.
However, specific circumstances can allow for higher DTI ratios. For example, Suppose their credit scores are more than 580. They can offer verifiable proof of access to cash reserves or extra income sources. In that case, applicants with back-end DTIs as high as 50% may qualify for FHA loans.
Conventional Mortgages
A conventional mortgage is issued directly from a credit union, bank, or mortgage lender. They are also known as conforming mortgages.
This is because they meet the conditions for purchase by Fannie Mae and Freddie Mac. These government-sponsored firms purchase practically all single-family home mortgages and bundle them into securities traded like stocks.
Conventional mortgages require applicants to have 43% or lower back-end debt-to-income ratios. Applicants with a high credit score as well as other income streams and ample assets can have a DTI requirement as high as 50%.
PRO TIP: Conventional Mortgages are not government-backed.
Take Charge of Your Finances
Your debt-to-income ratio is vital for evaluating your financial strength and capability. Understanding your DTI performance helps you make more informed decisions about your finances and take other significant life steps.
Take Off Financial is a credit repair company dedicated to assisting people in managing their debt and finances better. If you are struggling to lower your DTI ratio and looking for a way forward, let our high-end professionals work with you to find a solution. Contact us today and take control of your finances.
