- 3 min read
- Debt to income (DTI) measures the percent of your income that is paid toward debt.
- Don't borrow more than you can comfortable repay.
- When you apply for a mortgage, measure combined debt to income and try to keep it below 35%.
Understanding your Debt-to-Income Ratio is an Important Part of Knowing your Financial Options.
You need to learn about your debt-to-income ratio (DTI), if you want to monitor your overall financial situation.
DTI is a formula that compares certain debts you have to your gross income. To calculate your debt-to-income ratio, take your monthly debt payments (for you house, credit cards, and vehicle, student loan, and alimony or child-support) and divide it by your monthly gross income. If you have a debt that you will pay off in 6 months by making your normal payment, it may not be counted in your DTI .
Items such as monthly food expenditures, utility bills, and entertainment expenses are not included in your debt-to-income ratio. Though you clearly have to budget money to pay for these expenses, they are not used by lenders when calculating your DTI.
Debt-to-Income Calculation Example
If you make $4,000/month,before taxes, this is your gross monthly income. Let's assume that you have a car payment of $400/month and a house payment of $1,200/month, and a monthly minimum payment on your credit cards of $250/month. The total of these monthly expenses is $1,850.
To establish your debt-to-income ratio, divide your monthly debt payment by your monthly income. The end result is your debt-to-income ratio.
- Monthly income: $4,000
- Monthly debt payment: $1,850
- Debt-to-income ratio: $1,850/$4,000 = 46%
What Does Your DTI Mean?
Now that you know your debt-to-income ratio, it’s time to discover what your ratio is telling you. If you have a ratio of 30% or less, it means you have a great debt-to-income ratio, meaning your income is significantly more than what you owe. However, if you have a debt-to-income ratio of 44% or higher, it means you are taking on too much debt in relation to your income, in the eyes of mortgage lenders. It used to be the case, before the sub-prime loan market collapsed, that lenders would offer you a loan if your DTI was up to 55%, provided you met the other lending requirements. Today, a DTI above 44% makes it very hard to qualify for a mortgage.
Debt-to-Income Ratio Info graphic
debt-to-income ratio and lenders
lenders calculate and analyze your debt-to-income ratio to determine the size mortgage you can afford. in fact, your dti, your loan-to-value (ltv), and your credit scores are the most important numbers that lenders look at when deciding whether you qualify for a loan or in quoting you a mortgage amount and interest rate.
if are thinking to yourself, should i refinance my home and want to know if you will get the best rates from a refinance lender, make sure that your dti, credit score, and loan-to-value are all strong.
your debt-to-income ratio tells you a lot about your financial health and your chances of qualifying for a mortgage loan. the best thing to do is to keep your debt under control and avoid taking on too much debt. to much debt can prevent you from qualifying for a mortgage and send your finances plummeting.
In your case, your DTI will be based on your monthly gross household income and the required principal, interest, property taxes on both the first home loan and the one you would apply for on the second, and your monthly required payments for any auto loans, student loans, credit card accounts, personal loan accounts, alimony or child support, and legal or tax assessments you have.