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.

What Mortgage Lenders Are Looking At

When you apply for a mortgage, lenders don’t just look at how much you owe, your income is also a large factor. A couple’s and individual’s debt, including the new house payment, should not be more than 35% of the gross income.

Also, what is very important is the money you put down on the home. The more you put down the lender feels the less risk he takes on and the more likely you are to get the mortgage. Especially in today’s market, lenders are looking for very clean borrowers.

Next, lenders look at your credit score and the debt that is owed. Lenders divide debt into two categories; installment loans and revolving loans. Student loans, mortgages and car loans, which require you to pay a fixed amount each month, are considered on the installment side.

Your student loans do have an effect, but not necessarily negative. When credit scores are calculated, student loan debt is viewed more favorably than credit card debt. Owing a lot of money in installment debt is not going to hurt your credit score as much as maxing out your credit cards.

Many young adults often get themselves into trouble by blowing off their student loans. In 2006 the default rate of federally sponsored loans was more than 12%. That might not
Seem like much, but when you realize that even in the current mortgage “crisis” only 5.1% of mortgage payments were late in the second quarter of this year.

New graduates usually build their credit history based on credit cards and student loans. That is why it is so important to make all of your payments on time. Before you take on a mortgage, eliminate as many other financial commitments as you can. Pay down or even pay off car loans and any other debts possible.

When Your Student Loans Do Hurt Your Chance Of Getting A Mortgage

Not paying your student loans will adversely affect your lives and credit for many years. You have entered into a contract with a company and if you do not fulfill your part of the contract the financial nightmare can follow you for a long time.

Students have been given several options to aid them when they need help in the repayment process. We’ll start from the top and move on down. First is the standard repayment, which is the normal schedule on a monthly payment basis.

Next is the extended repayment program, which stretches the payments to 25 years. This however, increases the total amount of interest over the life of the loan.

The graduated repayment program is designed for borrowers who anticipate making increasing financial progress over time. It begins with interest-only payments up to four years then payments gradually increase. This also increases the total amount of interest the borrower pays over the life of the loan.

Income-Sensitive repayment program is for borrowers who do not earn enough to cover their loan payment. An arrangement is made for payment between 4% and 25% for the gross monthly income up to five years and once again the interest increases over the life of the loan.

The last and I believe is the smartest and most popular program is the consolidation repayment option. It allows borrowers to combine multiple loans into one, extend the repayment term, and, in some cases, lower the monthly payment.

There are ways to help you out when you are in trouble with repaying your student loan, however, these do not help you when it comes to applying for a mortgage.