DTI: Debt to Income Ratio in Home Loans
What is a Debt to income ratio?
DTI, or debt-to-income ratio, is a measurement that banks and other lenders use to compare an individual’s debt payments to their overall income. They usually use this as a way to determine someone’s predicted ability to repay future debts. You can calculate DTI by dividing your total monthly debt (recurring expenses only), by your gross monthly income.
Here’s an example:
If you have a home loan of $1,000 and a car payment of $300, you’d have a total monthly debt of $1,300.
If you make $4,000 a month, that would be your gross monthly income.
$1,300 / $4,000= 0.325
Your DTI is 32.5%.
Overall, mortgage lenders love borrowers with lower DTIs, since studies show that these borrowers are more likely to pay their debts on-time and without any hassles. And why wouldn’t they be? It doesn’t take a rocket scientist to know that if you have more money, it’s a lot easier to pay your bills.
What expenses count as debts when calculating your DTI?
Pretty much any kind of monthly loan or debt counts toward DTI, including auto loans, personal loans, credit card debt (which is calculated as the minimum monthly payment), garnishments and other court-ordered payments, like alimony, child support, and any student debt you may have.
Depending on the individual lender, your current rent or lease payment will not usually count toward your DTI (since you likely won’t be paying it once you have your new home), but it might. For this reason, it’s a good idea to ask a prospective lender exactly how they’re calculating your DTI.
Other living expenses, like food, non-recurring medical costs, cable, internet, gas, and electricity are not counted as part of DTI.
What kind of DTI do I need to get approved for a mortgage?
In most cases, you’ll need to have a DTI of 43% or less to get approved for a mortgage. Despite that, having a DTI of less than 36% is best, and may be able to get you a much lower interest rate.
How can I improve my DTI to get a better loan?
There are really only two main ways to improve your DTI: reducing your monthly debt expenditure and increasing your income. For example, if you have credit card debt, you could reduce your debt expenditure by paying down nor paying off your card balance.
In other cases, you could try to pay off your auto loan, or refinance your vehicle into a loan with a lower monthly payment (though this might not be right for everyone.)
The other method, increasing your monthly income, might be easier said than done -- but hey, don’t stop working at it!