What is debt-to-income ratio?
Your debt-to-income ratio (or DTI) will play an important part in home purchasing, refinancing and home equity lines of credit. But what is it exactly? Simply put, it is the percentage of your monthly income that is taken up by your monthly debt payments.
How to calculate it
Lenders calculate your debt-to-income ratio by using these steps:
- Add up the amount you pay each month for debt and recurring financial obligations (such as credit cards, car loans and leases, or student loans). Don’t include your current mortgage or rental payment or other monthly expenses that aren’t debts (such as phone or electric bills) in this number.
- Add your projected future mortgage or home equity line of credit payment to your debt total from step 1.
- Divide that total number by your monthly pre-tax income. The resulting percentage is your debt-to-income ratio.
For example, if your monthly income is $5,000 and your monthly debts plus your monthly projected mortgage or home equity line of credit payments are $1,000, your debt-to-income ratio would be 20%.
Lowering your debt-to-income ratioMost lenders will want your debt–to-income ratio to be no more than 36%, but some lenders or loan products may require a lower percentage in order to qualify.
If your DTI ratio is too high, consider how you can lower it. You might be able to pay down your credit cards or reduce other monthly debts. If the proceeds from your current home’s sale plus your savings allow it, you may also want to increase the amount of your down payment, in order to lower the projected monthly mortgage payment. Or you may want to consider a less expensive home.
Also keep in mind that there are alternative sources of income. Some lenders may consider other non-traditional sources of income (for example, trust income or housing allowance) in addition to your traditional income. Be sure to ask your lender about the availability of mortgage products and programs that allow the use of non-traditional sources of income.
By understanding what your debt picture looks like, you can develop a plan to tackle it.
Want to estimate what you would pay each month? Use our mortgage payment calculator