What Is The Debt To Income Ratio?

DTI: Debt-to-Income Ratio

The dictionary meaning is: the ratio of a borrower’s total of debt as a percentage of their total gross income. In this particular article we will be using this term and referring to it as an example relating to mortgages. However, it can be used for almost any loan.

Your debt-to-income ratio is a simple way of showing what percentage of your income is available for a mortgage payment after all other continuing obligations are met; or, the relationship between what you owe and what you make.

Debt is a problem that plagues many of us today. If unmonitored, your debt can grow at an alarming rate and the next thing you know your finances are in shambles. If you want to identify your overall financial situation and keep your debt in check, you need to establish your debt-to-income ratio.

How To Calculate Your Ratio

You will usually see conventional loan debt limits referred to as the 28/36 qualifying ratio (or other numbers up to 36/42 depending on the type of loan). These numbers refer to two percentages that are used to examine two areas of your debt load.

The first number indicates the maximum percentage of your monthly gross income that the lender will allow for housing expenses. This includes loan principal, interest, private mortgage insurance, hazard insurance and property taxes.

The second number refers to the maximum percentage of your monthly gross income the lender allows for your housing, credit cards, car loans and other obligations that will not be paid off within a short period of time (6-10 months).

Items such as monthly food bills, utility bills and entertainment expenses should not be considered when calculating your debt-to-income ratio. These expenses can be paid off monthly.

To calculate your ratio, take your monthly debt payment and divide it by your monthly take home income. The end result is your debt-to-income ratio. Let’s look at an easy example:

Monthly income: $4,000

Monthly debt payment: $1,850

Debt-to-income ratio: $1,850 / $4,000 = 46%

If you have a ratio of 10 percent or less, it means you have a GREAT debt-to-income ratio, meaning your income is quite a bit more than what you owe. However, if you have a debt-to-income ratio of 55 percent or higher, it means you have too much debt and are considered a risk for a mortgage loan.

Debt-to-Income Ratio and Lenders

Lenders calculate and analyze your ratio to determine the size of mortgage you can afford. In fact, these numbers are frequently the most important numbers that lenders look at when quoting you a mortgage amount and interest rate.

These numbers not only determine if you qualify for a mortgage loan, but the monthly payment you will be paying and for how many years. These numbers tell the lender a lot about a person and how they handle their money.

So in the end, the best thing to do is to keep your debt under control and not to take on too much. It could hinder your ability to qualify for your dream home and if not, it would send your finances plummeting.