First-Time Buyers: Here’s How to Calculate Your Budget

Your DTI compares your monthly debt payments to your gross monthly income (the amount you earn before taxes and deductions). It’s a key factor lender’s use to evaluate your ability to handle mortgage payments.

There are two types of DTI:

1. Front-End Ratio: Focuses on housing expenses, including your mortgage payment, property taxes, homeowner’s insurance, and any HOA fees.
2. Back-End Ratio: Includes all monthly debt obligations, such as housing expenses, car loans, student loans, credit cards, and personal loans.

Ideal DTI Ratios for a Mortgage

While each loan program has different requirements, these are the general limits:

Loan Program	Front-End DTI Limit	Back-End DTI Limit
Conventional Loan	Up to 28%	Up to 36-45% (may go higher with strong credit)
FHA Loan	Up to 31%	Up to 43-50%
VA Loan	No strict front-end limit	Up to 41% (can exceed if residual income is strong)
USDA Loan	Up to 29%	Up to 41%

What Goes into the DTI Ratio?

Payments Included in the DTI Calculation:

• Monthly mortgage payment (principal, interest, taxes, insurance, and HOA fees).
• Auto loan/lease payments.
• Minimum credit card payments.
• Student loan payments.
• Personal loans, child support, or alimony payments.

Payments Not Included in the DTI Calculation:

• Utilities (e.g., electricity, gas, water).
• Groceries and everyday living expenses.
• Health insurance premiums.
• Subscriptions, such as streaming services or gym memberships.

Calculating How Much House You Can Afford

The mortgage industry uses gross income to calculate DTI ratios. However, it’s important to consider your net income (your take-home pay) since you use that to pay your bills.

Step 1: Estimate Your Front-End DTI
For example, if your gross monthly income is $5,000 and your front-end limit is 28%:

• $5,000 × 0.28 = $1,400
  This means you can afford a maximum monthly housing payment of $1,400.

Step 2: Account for Your Back-End DTI
Let’s say your monthly debts include:

• $200 for a car loan
• $100 in minimum credit card payments
• $300 for student loans

Add these to your estimated housing payment of $1,400:

• $1,400 + $200 + $100 + $300 = $2,000

Now divide $2,000 by your gross income ($5,000):

• $2,000 ÷ $5,000 = 40%

This is your back-end DTI, which might be acceptable for an FHA loan but could push the limits for a conventional loan.

Balancing Gross vs. Net Income

While lenders calculate affordability using gross income, you’ll pay your bills with your net income. It’s crucial to account for taxes, retirement contributions, and other deductions to ensure your budget remains realistic.

For example, if your gross monthly income is $5,000 but your take-home pay is $3,800, that $1,400 housing payment represents a larger chunk of your disposable income (37% of your net income). This is why it’s wise to stay well below the maximum DTI limits.

Tips for First-Time Buyers

1. Budget for Unexpected Expenses: Homeownership comes with extra costs like maintenance and repairs.
2. Consider Long-Term Affordability: Ensure your mortgage fits your lifestyle and financial goals.
3. Work with a Professional: A mortgage advisor can guide you through loan options and help you find the best fit.

Conclusion

Understanding your DTI ratio is a crucial step in determining how much house you can afford. While lenders focus on gross income, make sure to calculate your affordability based on your net income for a realistic view. By staying informed and planning carefully, you’ll be well on your way to achieving your dream of homeownership in Southeast Michigan.

Need guidance? Reach out today for personalized advice tailored to your financial situation.