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Mortgage Guide

How to get a home loan

Debt-to-Income Ratio: What is it and how is it calculated?


Have you ever wondered how mortgage lenders determine if you can afford a home? The answer is found in your debt-to-income ratio or DTI. Your debt-to-income ratio is the sum of all your monthly debts divided by your gross monthly income. Your DTI tells us how much of your income is needed to pay your current monthly debts and how much is available for a mortgage payment.

How does your DTI relate to mortgage affordability?

Your debt-to-income ratio compares how much you owe to how much you earn each month. Let’s think about your monthly budget. Each month you earn a certain amount of money. You also have recurring debts and expenses. If you make $5,500 each month and spend $1,500 each month on a mortgage, $400 car loan, $270 credit cards, and $200 student loans, it appears you have $3,130 left over. But this is not the case. We calculate your DTI based on your gross income, but in reality, you are not bringing that amount home each month. Income taxes reduce your spendable income. Maybe $1,000 in taxes are taken out each month so instead of bringing home $5,500, you bring home $4,500. Then you pay your debts ($2,370) and are left with $2,130. You would still need funds available for utilities, food, entertainment or other expenses which would not be tracked on your credit report. Lenders place a cap on DTI to be sure you have funds available for these living expenses.

Many studies have been done on DTI and plenty of data has been evaluated. The results are clear: Those who consistently maintain on-time payments of their financial obligations have no more than 43% of their income allocated to debt payments. As a result of this research, most lenders will approve mortgages for borrowers whose debts (including a mortgage payment) are at or below 43% of their monthly income. However, there are loan programs that can use higher DTI numbers.

So, how do you calculate your debt-to-income ratio?

DTI-ratio-chart-expenses

Step 2: Divide your total monthly debt by your gross monthly income (before-tax income).Note that the debts used to calculate your DTI are those that would appear on your credit report. 

DTI-1-1

Step 3:  Multiply the result by 100 to convert the answer into a percentage.

dti-43-percent

What types of income are used in the DTI?

  • Salaries (Example: W2 income)
  • Tips and bonuses (special calculation)
  • Pension
  • Child support
  • Alimony
  • Social Security
  • Other sources of additional income

What types of monthly payments are included in debt-to-income?

  • Co-signed loan monthly payments
  • Monthly child support payment
  • Monthly alimony payment
  • Monthly minimum credit card payments
  • Monthly student loan payments. For more information, read about how student loan payments are calculated when qualifying for an FHA loan.
  • Monthly real estate taxes
  • Monthly expense for homeowners insurance
  • Monthly car payments
  • Monthly mortgage payments

Expenses such as gas, utilities, groceries are typically not included in the DTI ratio.

DTI ranges:

DTI-range-example

Our DTI calculator displays the results when you complete our online mortgage application where will see your personal DTI.  

  • Green: 35% or less DTI is a good manageable debt level.
  • Yellow: 35% to 43% DTI indicates opportunity to improve.
  • Red: 50% or more DTI shows need to take action to lower your ratio as more than half your income is allocated toward debt payments and lenders view this as a negative on your loan application.

DTI is just one part of underwriting a loan. Standards and guidelines vary.  Some loan programs can accept a 50% DTI ratio.

How do you reduce your debt-to-income ratio for a mortgage?

  1. Make more money or reduce your monthly payments.  
  2. Get removed from co-signed loans (or prove another borrower has made the payments over 12 months).

The debt-to-income ratio is used by lenders to ensure you can repay your loan. If you have further questions about DTI or any part of the mortgage loan application process, give me a call at 314-474-0961. Or, you can start the mortgage application today.

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