The Debt-to-income ratio is the percentage of a consumer’s monthly gross income that goes toward paying debts. DTI is a measure of risk, it allows lenders to determine the likelihood of loan repayment. Most lenders prefer a DTI Ratio of below 36%, but it can go as high as 43%. The general rule is, the lower the DTI, the higher the chance of getting a loan/credit. 

Calculating DTI Ratio 

To calculate your DTI ratio, add up your recurring monthly debt payments, and divide by your gross monthly income. 

For example, if your total monthly debts were $2,300 and your gross monthly income was $5,200, your DTI ratio would be: (2300/5200)*100=44%. This gives the value of the back-end DTI. 

Lenders may also include the front-end DTI, which only considers debt directly related to a mortgage payment i.e. the sum of rent, tax, insurance, and homeowners fees.  For example, if your housing costs are $1,150 and your gross monthly income is $5,200, so your front-end DTI: ($1,150/$5,200)*100=22%. The preferable ratios are between 28-31%. 

What is a good DTI Ratio? 

DTI Scale
0-35% Good-shows that the borrower can repay debt and has healthy finances 
36-43% Opportunity to improve. You are managing your debt adequately and you might qualify for small loans. 
44-50% Must improve. Will make it difficult for you to get a mortgage. 
>50% High debts. You have limited funds to save or spend. You must start reducing your debt to get a mortgage. 

DTI Ratios and Mortgages 

Your DTI ratio is a major factor in the mortgage approval process. Generally, lenders prefer to see a debt-to-income ratio of less than 36%, with no more than 28% of that debt going towards servicing your mortgage. The total debt must not exceed 43%, above that the lender will deny your mortgage. 

Conventional home mortgages are not backed by the government and are given directly to the borrower from the bank/lender. They require a back-end DTI ratio below 43%, and in certain cases can go up to 50%. Unconventional mortgages are backed by a government agency and have a stricter range of DTI ratios. The front-end DTI ratio can go up to 31% and the back-end DTI can be 43% max. 

DTI and Credit Score 

The DTI ratio doesn’t directly affect your credit score, as the credit agencies don’t know your income. They do, however, look at your credit utilization ratio, which compares your credit card account balance to the total credit. 

The debt-related factors which influence credit scores are: 

  1. Overall outstanding debt
  2. Credit mix 
  3. Credit utilization 
  4. Payment history 

Improving DTI Ratio 

There are 2 ways to improve your DTI ratio: 

  1. Reducing monthly debt 

Start by calculating your total debt and then look at your monthly payments. Try nonprofit debt management, as it lets you consolidate your debt payments with a high debt-to-income ratio because you are not taking out a new loan. This will lower your interest rates, which lowers your monthly payments and in return monthly debts.

Other ways include: 

  • Canceling subscriptions 
  • Avoiding large purchases 
  • Refinancing loans
  • Sell unwanted items online 
  1. Increasing income 

You can improve your income by: 

  • Ask for a raise at work 
  • Start a small scale business 
  • Freelancing 
  • Getting a second job 
  • Enhance your skillset to 

The debt-to-income ratio is an important measure of your financial security. The lower it is, the more affordable your debts are the more risks you can take, and the higher the likelihood of you getting a mortgage. The ideal DTI ratio is below 35% but you are in a safe zone to 43%.

Contact us at (605) 718-9820 or schedule a call and let our mortgage experts help you with your home loan.

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