Decoding Debt-to-Income Ratio in Mortgages
Understand how debt-to-income ratio affects your mortgage with this in-depth look at this key financial metric. Gain a clearer picture of the implications of this ratio for a successful home purchase.
What is a Debt-to-Income Ratio?
A debt-to-income (or DTI) ratio is a financial metric used by lenders to determine a borrower's eligibility for a loan. The DTI measures the ratio of your existing debt obligations (such as your credit card debt, car payments, student loans, and other recurring debt) compared to your gross monthly income. The higher ratio is, the more heavily in debt the borrower is considered to be.
The Importance of a Low Debt-to-Income Ratio
A low DTI ratio is important when it comes to mortgage applications, as lenders often view a high DTI ratio as a sign of financial distress in the borrower. The lower the ratio, the more loan dollars a lender is typically willing to allocate to the borrower. Thus, anything below 38 percent is considered good for mortgage-related applications.
How to Calculate Your Debt-to-Income Ratio
Calculating your DTI is fairly simple and requires only a few pieces of information. You'll need to add up all your debts, including any credit card payments, student loans, and housing expenses. Then, your total monthly income should be divided by this debt amount. This number should be expressed as a percentage, and creditors typically use the figure to determine if an applicant is eligible for a loan.
For example, if a borrower's total debts add up to $2,000 per month and their gross monthly income is $4,000, that would be a DTI ratio of 50%.
Tips for Improving Your Debt-to-Income Ratio
If you have a high DTI ratio, it's important to lower it before applying for a loan. Some of the best ways to lower your DTI include:
- Paying down existing debt
- Making additional payments on existing debt
- Increasing your income
- Securing a co-borrower or cosigner
Improving your DTI ratio can help you get approved for a mortgage more quickly and easily, so it's important to understand how it works and how to manage it.