Understanding Debt to Income Ratio (DTI)

Is the terminology of the mortgage process making your head spin?  If you’re out there looking at homes, I’m sure you’d rather focus on the one with the killer yard and outdoor shower than learning terms like “debt to income ratio”.  If this term popped up on your radar, I’d love to help you learn what it means.

Hi, I’m Phil from A Nightmare on Loan Street Blog.  I write about the mortgage process, loans, and alternative lending…especially if things seem to go sideways.  

Today, I’m going to review “debt to income ratio” or DTI.  This is a helpful tool that lenders use to evaluate a borrower’s available cash flow.  This ratio lets a lender know the likelihood that a borrower will be able to make the monthly mortgage payment.  

Lenders combine your debt to income ratio along with your credit score, down payment amount, and financial records to see your overall financial picture.  

As with any ratio, there is a top number (monthly debt) and bottom number (gross monthly income).  Let’s complete an example calculation so you can see how this works (no calculator needed - put away your TI-81 from 10th grade).

Let’s say you make $3,000 per month, and you have $1,400 per month in debt (things like student loans, credit card bills, car payments, etc…).  We just take 1400/3000 = 0.46666 and BAM!  That’s a debt to income ratio of 47%.  This tells the lender that of the money you make each month, you spend 47% of it on predictable/recurring debt. 

You’re probably like “ok Phil, I got it.  I understand how to calculate my ratio.  So what percentage am I aiming for?”.  Great question.  Most lenders are looking for a debt to income ratio of 42% or below.  Remember, the lower the number, the better - like Godfather sequels.  C’mon, Part 1 is definitely better than Part 2.  And don’t even bring up Part 3…what a train wreck.

If your debt to income ratio is higher than 42%, you have a couple of options to lower your number.

1. Increase your monthly income.  Riiiiiiiight.  Easier said than done.  But these days, having a side hustle and doing it from home on your terms is definitely possible.  Just think of everyone you went to high school with who is now trying to get in touch with you on Facebook to join their “team” and sell organic shampoo.  
2. Decrease your monthly debt.  This may be the easier of the two paths.  It’s actually a double whammy because if you can eliminate some monthly debts, you will not only improve your debt to income ratio, but your credit score will likely increase as well

I’m going to also throw in a couple of Phil’s Special Debt to Income Ratio Blog Post Tips here.  First, take the time to calculate your debit to income ratio BEFORE applying for a mortgage.  If needed, decrease your monthly debt to improve your DTI.  Finally, avoid taking on any new debt right before applying for a mortgage.  

Debt to Income ratio is not the only number that lenders review during the mortgage process.  However, now that you know what this is and how to calculate it, hopefully you have a better understanding of what this means and why it might matter when applying for that loan.  Now go find that house with the outdoor shower.  Those things rock.