Debt-to-Income
Debt-to-Income
6/14/2023Debt-to-income ratio: What does it tell you and why is it important?
Mortgage loans exist to help make purchasing a home possible, taking the large purchase price and allowing the buyer to pay it over time with interest, month by month. It makes sense for a lender to determine a loan applicant’s ability to manage and pay monthly credit bills. The borrower also wants to feel confident that they can make their monthly mortgage payment while being able to meet other debt obligations they may have like student loans or credit card balances. The debt-to-income ratio, or DTI, is one way to assess the ability of a person to meet monthly debt obligations.
What is DTI?
The debt-to-income ratio is a calculation of the amount of your monthly income that goes to make debt payments, usually expressed as a percentage. To calculate DTI, first add up all monthly debts, such as payments for rent, mortgage, car loans, student loans and credit card payments. Do not include things like utilities, groceries, daycare fees and other regular monthly expenses, just your debt obligations. Then take that total and divide it by your monthly gross income, multiply the number by 100 and you have your DTI percentage.
Lenders like to see their borrower’s DTI no higher than 40%. Borrowers with higher DTI figures are at a greater risk to default on their loans in the event of a financial hardship or other reduction in income. A lower DTI indicates that a borrower will be able to weather difficult times, since they do not have as much of their money dedicated to making regular debt payments.
Having a high DTI does not mean you cannot qualify for a mortgage loan. You may have a higher interest rate to account for the added default risk. Your lender may also be able to help you find other loan programs you qualify for that have less restrictive DTI requirements. Ultimately, DTI is one measure of your risk as a borrower. Other factors like your credit score, amount of assets and size of your down payment will also play a role in your qualification and may outweigh DTI concerns.
How to lower your DTI
If your DTI is a barrier to getting the home financing you need, there are things you can do to lower your ratio:
- Pay down your debt.
Reducing your debt by making regular payments above the minimum required payment amounts is the best way to lower your DTI. It may take some time, but paying off your debts will make you a more attractive borrower and help you get the best loan terms. One popular plan to eliminate debts is the rollover strategy. Learn more about this method and find out how soon you can eliminate your debts with this calculator:
How soon can I eliminate my debts?
- Negotiate lower credit card rates.
If high interest credit cards are part of your debt load, you may have success asking the credit card company to reduce your rate, especially if you have been a loyal customer and have had no instances of late payments. If you wonder how a lower rate will affect the time it takes to pay off your card, you can use this calculator to run scenarios:
How long will it take to pay off my credit card?
- Consolidate your debt into a lower rate option.
Odds are, if you have multiple debts, they are all at different interest rates. Debt consolidation may be a good option to simplify your debt payments, lower your overall interest expense and save money. One option is to transfer balances from higher-rate credit cards to a card with a lower rate. Another way to consolidate is by taking out a personal loan with a lower interest rate. Use it to repay your other debts, then gradually pay off the personal loan over time. The following calculator can help you determine if debt consolidation is a good idea for your situation:
Should I consolidate my loans?
- Don’t take on more debt.
This may seem obvious, but adding more monthly debt payments will negatively affect your DTI. With the exception of taking out a loan to consolidate your existing debts, you’ll want to avoid going deeper into debt or financing any new large purchases as you work to improve your DTI.
Get informed
Before you attempt to get a mortgage, it is worth taking time to assess your current debt payment situation and understand how much of your income is going to pay off what you owe. You’ll want to be confident that you can afford to take on a monthly mortgage payment. If you need help calculating your DTI and wonder how it may impact your ability to get a home loan, talk to one of our experienced lenders. They stand ready to serve.
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