What is DTI?
If you are applying for a home loan, you will likely hear the term DTI. DTI stands for the debt-to-income ratio. Your debt-to-income ratio tells lenders how much money you owe other creditors and how much money you are bringing in each month. Even if you have excellent credit and always make your payments on time, lenders still limit how high a borrower’s DTI can be.
What DTI do lenders look for?
Lenders look for a DTI at or below 36 percent. If your DTI is somewhere between 36 percent and 49 percent, consider it an opportunity for improvement. If your DTI is at 50 percent or more you may not have enough money to handle unexpected expenses. Lenders may limit your borrowing.
Can I buy a house with high DTI?
A mortgage applicant’s DTI ratio is a key factor that lenders consider during loan approval. This ratio helps to determine the likelihood that the applicant will be able to consistently afford to make their monthly mortgage payments. A high DTI tells lenders that an applicant may struggle to pay their obligations each month. The bottom line is that lenders want to make sure that the borrower can afford the mortgage.
How is DTI calculated?
DTI ratio is calculated by adding up all of an applicant’s monthly debt payments and dividing that sum by their gross monthly income. For example, a couple applying for a home loan makes a combined $6500 a month before taxes, and they have the following payments:
Mortgage Payment: $1100
Car Payment: $425
Student Loan Payments: $500
Total Monthly Debt: $2025
The applicants’ $2025 monthly debt divided by their monthly income of $6500 equals a DTI of 31.2%.
Your gross income is the amount of money you bring in before any money for taxes and other deductions are taken out. Any income from alimony or child support, investments, Social Security or pensions, bonuses, and tips are combined with your wages or salary to determine your gross income. Your gross monthly income is determined by taking your annual gross income and dividing it by twelve.
Not all monthly payments contribute to DTI. Generally, only revolving or installment loans are factored in. This typically includes payments toward mortgage or rent, auto loans, student loans, credit cards, alimony, child support, and personal loans. If your mortgage is escrowed, then your property taxes and homeowner’s insurance will likely be included. Things like cell phone bills, utilities, childcare, car insurance, and groceries should not affect your DTI ratio.
The maximum debt-to-income ratio will vary by lender and loan type, but the number generally ranges between 40-50%. Contact your bank or mortgage broker to learn more about DTI and mortgages.
It’s good to know your DTI and make sure that it is acceptable as you begin speaking with lenders. Use a mortgage calculator to see your future mortgage payments and apply that information to discover your DTI. If your DTI is over the maximum allowable, you may have to put your home-buying plans on hold until you have an opportunity to lower it.
What is considered a good DTI?
Anything below 45% is usually considered a good DTI ratio. Most lenders require that home loan applicant’s DTI be below 45% to be approved for a mortgage. However, some lenders might go higher if the applicant has excellent credit and will still have substantial cash on hand even after making a large down payment. Contact your mortgage broker to have your home loan related questions answered.
Many younger applicants are finding themselves unable to purchase a home due to high DTI ratios. This is often due to substantial student loan debt. Some lenders, including Fannie Mae, raise their DTI maximum to 50% to help accommodate and make homeownership possible for millennials.
How to lower your DTI?
Debt consolidation may be helpful if you are trying to lower your DTI ratio. Although your total debt typically remains the same, you may end up with a monthly payment lower than the sum of all the individual payments. The lower payment might make it easier for you to increase the amount you pay each month toward your debt.
Resist the temptation to take on more credit card debt. Consider locking up your credit cards. Only use them enough to keep them active. Don’t carry a balance. If there is a balance on your credit card, pay your bill in full before your statement due date.
Auto loans are another big contributor to high DTI ratios. Saving up and paying for cars in cash can eliminate the need for car loans. A reliable used car will likely meet your needs just as well as a shiny new one but without a large monthly payment.
Postpone large purchases to keep your credit utilization low.
Are you interested in finding out more about DTI and your mortgage? Contact one of our expert mortgage professionals and learn about your home loan options.