Understanding Debt-to-Income Ratio


When you decide to buy a home, your debt-to-income ratio (DTI) is one of the major factors in determining if you qualify for a mortgage loan, and how much you qualify for. Your DTI is all of your monthly debt payments divided by your gross monthly income. This gives the lender a better idea if you are able to make all of your monthly payments and if you will be able to make your payments on a mortgage loan.

How to Calculate Your DTI

To calculate your DTI on your own, add up your monthly bills, which may include rent or mortgage, child support payments, student loans, auto loans, and credit card payments. Things like utilities, gas, taxes, and groceries are not included in this.

Then you divide that total amount by your gross monthly income, which is your income before taxes. You will end up with a percentage that represents your DTI. The lower it is, the better you will look to a lender.

How DTI Impacts Your Mortgage Application

If your DTI is too high, usually anything higher than 43 percent, you may not be able to secure a loan, and if you can, you may be paying a higher interest rate, and you may need a larger downpayment.

Before applying for a mortgage loan, try to calculate your DTI on your own. If it is above 50 percent, you may not be able to find any lenders willing to give you a loan; if that is the case, try coming up with a plan to begin lowering your DTI and try again once it is under 50 percent.

Types of DTI

There are two types of DTI ratios, the front-end and the back-end.

The front-end ratio is also known as the household ratio. It is the dollar amount of your home expenses, things like rent or mortgage payments, property taxes, and any homeowners association fees, divided by your gross income.

The back-end ratio takes all of your other debts into account in addition to your home-related expenses. This is higher than the front-end because it factors in so much more.

Which One is More Important?

The back-end ratio is usually the one that carries more weight with a lender, because it takes all of your debts int account.

Lowering Your DTI

If your DTI is too higher, or just higher than you would like, there are a few things you can do to lower it. The first is to avoid taking on more debt; for example, taking out an auto loan will raise your DTI instead of lowering it. Avoid making big purchases on your credit cards.

Paying off some of your debt will also help lower your DTI, but it can take some time. If you are within just a few months of paying off a student or auto loan, a lender might not take that into account.

Another thing you can do to reduce some of your DTI if you have student loans is to switch to an income-driven repayment plan, which should lower your monthly payments, thus reducing your DTI.

Increasing your income is another way to reduce your DTI, but that is not always easy to do.

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