When researching home equity financing, one can be inundated with all kinds of terminology and acronyms. Hopefully, we here at Irene can help you wade through some of the terms that matter most as you move towards using you home equity for more financial freedom. Two of the most common, and important, terms you you will run into are DTI and CLTV.
DTI ratio: Debt to Income.
Typically, lenders do not extend traditional home equity loans to homeowners with a DTI over 43%.
DTI stands for “Debt to Income.” Debt to Income is the percentage (or share) of your income that is required to pay your debts each month. Types of debt may include mortgage payments, real estate taxes, insurance, home equity loan payments, auto-loan payments, credit-card payments, alimony, and any other debt payments a person might make each month.
DTI is then calculated by summing up the total amount of one’s debt and dividing it by one’s total pre-tax income:
Total Debt / Total Income = DTI.
Here is an example. If your total debt includes a mortgage of $1,000 a month and an auto-loan payment of $200 a month, your total debt per month would be $1,200. If your total, monthly income is $2,400 a month, you would calculate your DTI Ratio as:
Example: 2,400 Monthly Income
$1,200(monthly debt) / $2,400 (monthly income)
.5 or 50% DTI
This means it takes 50 percent of your income to pay all of your debt obligations. Try out our calculator below to get a sense of your DTI:
Why does DTI matter to Seniors?
Lenders use DTI to determine your ability to repay your debt obligations. When looking to take out a home equity loan or line of credit, the lower your DTI, the higher your chances of getting approved—and with better terms. Typically, lenders do not extend traditional home equity loans to homeowners with a DTI over 43%.
DTI is a key barrier to senior homeowners ability to access any home-equity financing through traditional means. According to the Social Security Administration, 23% of married couples and 43% of unmarried individuals rely on Social Security for 90% or more of their income. At the end of 2017, the average monthly benefit payment for retirees was $1,404.
If we use this as a guide, we find that this large segment of the population can only access home equity lending if their debt is $600 per month or less ($1,404 X 43%). Since overall debt includes property taxes, and since some states’ taxes are quite high, it can be difficult for homeowners living on Social Security to qualify at all. (For example, in New Jersey, the average property tax expense is over $600 a month!)
CLTV: Combined Loan To Value
Lenders provide you access to home equity financing up to a certain CLTV, typically 80%.
What does CLTV mean?
CLTV stands for “Combined Loan to Value.” CLTV is the percentage of your home’s existing debt and liens, plus the new loan amount you hope to finance—all divided by the total value of your home.
This is why it’s called a “combined” value, because the debt includes your existing debt and liens (such as a mortgage, HEL, or HELOCs) and the new home equity solution you’re discussing with your lender.
Here’s a good example: Say your home is worth $500,000 and you have an outstanding mortgage of $150,000. You are hoping to get a $100,000 home equity loan. Your CLTV would then be calculated as follows:
Example: $500k Home
+ $100,000 (potential loan)
If market value of home is: $500,000 then
.5 or 50% CLTV
Your CLTV or potential combined debt is 50% of your home’s value.
Why does CLTV matter?
Lenders provide you access to home equity financing up to a certain CLTV, typically 80%. In the example above, you had a CLTV of 50% after a $100k loan. You could have qualified for a total of $250k with a CLTV of 80% - $150k more than you were hoping for.
Knowing how much you can ask for goes a long way in getting approved for a home equity loan or line of credit, saving you time and money in the process. Plus, understanding your DTI and your CLTV together, helps you know where you stand before you reach out to lenders. Home equity is a powerful thing, and by doing your homework, that power can sit squarely in your hands.
You can try our LTV calculator below: