The Debt-To-Income Ratio

BY: MELISSA ABRAMOVICH, MORTGAGE LOAN OFFICER

What is it, and why does it matter?

The debt-to-income ratio is the percentage of your gross monthly income that goes to pay your monthly debts, including your proposed mortgage payment. It helps lenders calculate an appropriate monthly payment and overall budget for what you can afford when applying for a mortgage on a new home. This, mixed with your credit score, are the two most important factors in qualifying for a mortgage.

A low debt-to-income ratio indicates that you have a good balance between your monthly debt and your monthly income. As an example, if you have a debt-to-income ratio of 20%, that means that you have roughly 80% of your monthly income left over at the end of the month for other expenses, and you are paying 20% of your monthly income to pay for debt, including housing costs. By contrast, you have a high debt-to-income ratio, it can indicate that you are overextended and have too much debt for the monthly income you earn.

Typically, borrowers with a low debt-to-income ratio look more attractive to lenders because it shows that they manage their debt effectively and demonstrates stability. Many lenders and loan programs cap the DTI at 43%, with some lenders preferring no higher than 36%

Debt-Income-Ratio Formula

To calculate your DTI, start by adding all of your monthly debt:

• Revolving debt (like credit cards)

• Auto loans

• Student loans

• Child support and Alimony

• Any other monthly debt obligations

Next, determine your gross (pre-tax) monthly income including:

• Base Wages/Salary

• Tips and bonsues

• Pension/Social Security

• Child support and Alimony

• Any additional income

Let’s look at an example:

Phoebe’s gross monthly income is a total of $6000 ($5000 from her primary job as an accounting clerk and $1000 from her secondary job as a yoga teacher). She also has a monthly debt total of $2300 ($1000 mortgage, $500 auto loan, $200 in student debt, $200 minimum credit card payments, and $400 in other monthly debt obligations).

To calculate the DTI, we divide the total recurring monthly debt ($2300) by her gross monthly income ($6000).

DTI=$2300/$6000=.38 .38x100= 38%

It’s important to note that this does not distinguish between different types of debt and the costs involved in servicing that debt. As an example, credit cards carry much higher interest rates than student loans, but they are packaged together in the DTI calculation. If you consolidated your higher-cost credit lines into a lower interest loan, your monthly payments would decrease, so your DTI would also decrease, even thought the total amount of debt outstanding would remain the same.

Keeping in mind the DTI, we also need to pay attention to your credit score--stay tuned!