How Debt-to-Income (DTI) Impacts Your Mortgage
Have you ever heard someone say you should only spend 36% or less of your income on bills? The concept they are referring to is that of debt-to-income, or DTI. Debt-to-income divides the total of all monthly debt payments by your gross monthly income, giving you a percentage. As a lender, we focus on your projected DTI calculated with your new monthly mortgage payment, because it’s a representation of your ability to pay your bills. Borrowers with high DTIs often have more trouble making their payments.
Whether you qualify for a mortgage depends on your mortgage lender’s standards and requirements – often using DTI, credit history, and gross income to determine if a borrower can repay a loan. To determine your DTI ratio, take the sum of all your monthly debts such as revolving and installment debt payments, divide by your gross monthly income and multiply by 100. If your ratio is lower, you may have an easier time getting a mortgage.
Here’s an example: A borrower with rent of $1,200, a car payment of $200, and credit card payment of $100 and a gross monthly income of $6,000 has a debit income of 25%.
A debt-to-income ratio of 25% is considered low. The Federal Reserve considers a DTI of 40% more of a sign of financial stress. Note that a debt-to-income ratio of 43% is generally the highest mortgage lenders will accept.
DTI does not distinguish between different types of debt. Credit cards carry higher interest rates than student loans, but they’re lumped in together in the DTI ration calculation. By transferring your balances from a high-interest rate credit card to a low-interest credit card, you monthly payments would decrease, lowering your DTI ratio.
Here’s a general rule-of-thumb breakdown:
DTI is less than 36%: Your debt is likely manageable. You shouldn’t have issues qualifying for a mortgage.
DIT is 36% to 42%: This level of debt starts to be a concern for lenders, but you may have trouble borrowing money. Consider paying down what you owe.
DTI 43% to 50%: Qualifying for a mortgage at this ratio will be difficult. Consider a debt management plan or debt consolidation.
DTI is 50%: Borrowing options will be limited.