Understanding your debt-to-income ratio
What is a debt-to-income ratio? Why is the 43% debt-to-income ratio important?
What is a debt-to-income ratio?
A debt-to-income, or DTI, ratio is derived by dividing your monthly debt payments by your monthly gross income. The ratio is expressed as a percentage, and lenders use it to determine how well you manage monthly debts -- and if you can afford to repay a loan.
Evidence from studies of mortgage loans suggest that borrowers with a higher debt-to-income ratio are more likely to run into trouble making monthly payments when cases of financial hardship arise. The 43 percent debt-to-income ratio is important because, in most cases, that is the highest ratio a borrower can have and still get a Qualified Mortgage.
Some lenders may still make a mortgage loan if your debt-to-income ratio is more than 43 percent, even if this prevents it from being a Qualified Mortgage. But they will have to make a reasonable, good-faith effort, following the CFPB’s rules, to determine that you have the ability to repay the loan.
How is the debt-to-income ratio calculated?
Here's a simple two-step formula for calculating your DTI ratio.
Add up all of your monthly debts. These payments may include:
Monthly mortgage or rent payment
Minimum credit card payments
Auto, student or personal loan payments
Monthly alimony or child support payments
Any other debt payments that show on your credit report
Keep in mind that other monthly bills and financial obligations -- utilities, groceries, insurance premiums, healthcare expenses, daycare, etc. – ARE NOT part of this calculation.
Divide the sum of your monthly debts by your monthly gross income (your take-home pay before taxes and other monthly deductions).
Convert the figure into a percentage and that is your DTI ratio.
For example, if you pay $1500 a month for your mortgage and another $100 a month for an auto loan and $400 a month for the rest of your debts, your monthly debt payments are $2,000. If your gross monthly income is $6,000, then your debt-to-income ratio is 33 percent. ($2,000 is 33% of $6,000.)
Does my debt-to-income ratio impact my credit?
Credit bureaus don't look at your income when they score your credit so your DTI ratio has little bearing on your actual score. But borrowers with a high DTI ratio may have a high credit utilization ratio -- and that accounts for 30 percent of your credit score.
Lowering your credit utilization ratio will not only help boost your credit score, but lower your DTI ratio because you're paying down more debt.
If you have additional questions concerning debt to income ratio or other mortgage financing questions give us a call at (405) 527-5669. We would be happy to help you.
Sources:
Debt to Income Ratio Calculator - Bankrate.com
What is a debt-to-income ratio? Why is the 43% debt-to-income ratio important? | Consumer Financial Protection Bureau | consumerfinance.gov