Your debt-to-income ratio, or DTI, signals your ability to repay a loan to your lender. A higher DTI means you carry too much debt compared to your monthly income, which could pose a greater risk to your lender.
By calculating your debt-to-income ratio, you can take the necessary steps to lower your DTI and get a better interest rate.
Here’s what you need to know about debt-to-income ratios, how to calculate DTI, and how it can impact your ability to qualify for a loan.
What Is Debt-to-Income Ratio?
Your debt-to-income (DTI) ratio is the percentage of your gross monthly income that goes toward your total monthly debt. DTI is an indicator of your financial health and lenders use it to measure your ability to manage monthly payments and pay back your loan.
Lenders look for a low debt-to-income ratio because it shows that you’re more likely to make monthly payments, and are therefore less of a risk. The lower your DTI, the better your chances of getting a loan or line of credit.
On the other hand, a high DTI can indicate that you have too much debt when compared to your income. This tells lenders that you may be overextending yourself and that taking on additional debt poses a greater risk.
There are also two types of debt-to-income ratios that a lender may evaluate: front-end DTI and back-end DTI.
The front-end debt-to-income ratio is the percentage of your monthly gross income that goes toward housing expenses. For example, mortgage payments, homeowners insurance, property taxes, and homeowners association fees.
To calculate your front-end DTI, add up all monthly household costs and divide it by your gross monthly income. Multiply the result by 100 for your front-end DTI as a percentage.
Back-end DTI shows the amount of your monthly income that goes toward minimum monthly debt payments. This includes housing expenses, lines of credit, student loans, car loans, and more.
To calculate your back-end DTI, add up minimum monthly debt payments and housing expenses and divide by your gross monthly income. Multiply the result by 100 and then you’ll have your back-end DTI as a percentage.
What Affects Debt-to-Income Ratio?
Several monthly payments are factored into your debt-to-income ratio. This includes:
- Rent or mortgage
- Property taxes
- Homeowners insurance
- Homeowners association fees
- Minimum monthly credit card payments
- Auto loans
- Personal loans
- Student loans
- Child support
Lenders may also consider the following sources of income:
- Social Security benefits
- Child support
- Additional sources of income
Here are payments that are not included when calculating your debt-to-income ratio:
- Car insurance
- Health insurance
- Contributions to a retirement account or savings account
Interested in learning if you qualify for a home loan? Find a Total Mortgage branch near you and speak to a mortgage advisor to discuss your loan options.
How Is Debt-to-Income Ratio Calculated?
Lenders calculate your debt-to-income ratio by comparing how much you owe each month to what you earn (before taxes). Here’s how your DTI is calculated:
- Add up all minimum monthly debt payments, such as rent, mortgage, credit card payments, and anything else that was listed above, if applicable.
- Divide your total monthly debt amount by your gross monthly income.
- The result should be a decimal. To get your DTI ratio, multiply that number by 100.
Let’s say your monthly gross income is $5,500 and you have the following monthly expenses:
- Rent: $1,200
- Minimum credit card payments: $100
- Student loan payment: $250
- Car loan payment: $325
Add these payments for a total of $1,875. Divide that number by your gross monthly income of $5,500 and then multiply by 100. Your DTI would be 32%.
What Is a Good DTI?
“What is a good DTI?” is a commonly asked question, but it depends on the type of loan and the lender.
In general, most lenders like to see a debt-to-income ratio below 43% to qualify for most conventional mortgage loans, says the Consumer Financial Protection Bureau, but some lenders may accept higher.
However, the lender will still look at other factors to determine whether you’re able to repay the loan.
How To Get a Loan With High Debt-to-Income Ratio?
You may still be able to qualify for a loan with a high debt-to-income ratio, but it might be more difficult to qualify.
Some government-backed home loans, like USDA, FHA, and VA loans, may accept higher DTIs, even up to 50%, but you should expect greater financial scrutiny.
Fannie Mae also accepts a maximum DTI of 50%, but only under certain circumstances and you must meet credit score and reserve requirements.
How To Lower Your Debt-to-Income Ratio?
If your debt-to-income ratio is too high, there are steps that you can take to lower your DTI. Here are some strategies to help:
- Pay down debt: Increase the amount that you pay toward monthly debt payments and avoid taking out new debt. Making extra payments can help lower your DTI.
- Refinance: You could potentially lower your DTI even more by refinancing to reduce your monthly debt payments.
- Increase your income: Increasing your income by picking up a side hustle could also help lower your DTI. However, may sure you have enough income history to satisfy your lender.
- Add a co-borrower: Another option is to add another borrower to your loan. When there’s more than one borrower on a single loan, the lender will determine your DTI using both incomes and debts.
Rate Shopping? Total Mortgage Is Changing Lending for the Better
Your debt-to-income ratio tells lenders how much of your monthly income goes towards paying off debts. If your DTI is high, it could affect your chances of qualifying for a loan or you may be asked to pay a higher interest rate.
A low DTI means a potentially lower interest rate and better loan terms. A better rate lowers the amount of interest your pay over the life of the loan and could reduce your monthly mortgage payments. Before applying for a loan, make sure to assess your financial situation and take steps to lower your debt-to-income ratio to score the best rate possible.
If you’re mortgage shopping, check out Total Mortgage’s loan program options when you’re ready to purchase or refinance. If you have any questions, schedule a meeting with one of our mortgage experts.
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