What Debt-to-Income Ratio (DTI) Is Good When Applying for a Mortgage?

Written by Credit Union of Texas
Published February 10, 2019
how to calculate your dti for mortgage application how to calculate your dti for mortgage application

What is DTI and why is it important?

DTI refers to your ‘debt-to-income’ ratio, and it is one of the ways lenders determine whether you can afford to take on a new loan. Your mortgage lender needs to be assured that you can repay the money you’ve borrowed, and of your ability to take on additional debt, like your mortgage. Your DTI score is one personal finance measure of that ability. Others include your credit history and the down payment you’re willing to make on the home.

What’s a good DTI ratio?

Lenders prefer a debt-to-income ratio of less than 36 percent, and no more than 28 percent of that ratio is going toward monthly payments on the new mortgage. The highest debt-to-income ratio to get a qualified mortgage is 43 percent. If your DTI is too high, it’s your loan application may be denied because your debts are too high compared to your income.

What is a qualified mortgage?

Before you take out a mortgage, your lender will make a good faith effort to ensure you’re able to make your mortgage payments. If your lender offers you a qualified mortgage, it means that the lender met the requirements of the ability-to-repay rule. These rules are designed to protect both the lender and the person taking out the loan. Your DTI score is one element of the ability-to-pay rule.

How do you calculate your DTI?

Debt-to-income ratio is calculated by dividing your recurring monthly payments on debt obligations by your gross monthly income.

Calculate your debt payments

Including your mortgage payment, make a list of all your recurring monthly payments on the following types of debt, and add the total:

  • Auto/boat/RV loans
  • Student loans
  • Credit card (minimum payments)
  • Medical bill payments
  • Equity loans
  • Child support/alimony
  • Other debt obligations

While this list of debts does not include payments you regularly make such as utilities, groceries or gas; it’s a good idea to create a monthly budget to keep your finances in check. Remember that lenders typically want your monthly mortgage payment to be less than 28 percent of your monthly income.

Calculate your income

Make a list of all your sources of gross (pre-tax) monthly income, and add the total:

  • Wages
  • Salary
  • Tips
  • Bonuses
  • Pension
  • Rental income
  • Investment dividends
  • Social Security
  • Child support/alimony
  • Other income
Calculate your DTI

Divide your total monthly recurring debt payments by your total gross monthly income. The figure will be a decimal. Multiply the figure by 100 to express the ratio as a percentage — this number is your DTI.

Finding an online debt-to-income ratio calculator is easy. Many of which will help you determine your mortgage payment if you know the home’s price, your down payment, your loan term, and your mortgage’s annual interest rate.

How can you lower your DTI?

There are basically two ways to lower your DTI: Either decrease your monthly debt payments, increase your monthly income, or a combination of both. There is usually not an easy method for either of these, but you can do it.

Lower your debt

The first step to decreasing your debt is to stop, or slow, the creation of new debt. While this approach won’t lower your existing debt, it will ensure your situation won’t get worse. You can put your credit cards away and commit to not using them, or even cut them up. If you freeze your credit accounts, lenders will not be able to pull your credit report or credit score, which they need to make credit decisions about you.

If you’re making only the minimum payments on your debt, it will take longer to reduce your debt, and you will have paid much more than what you charged. One strategy is to choose the debt with the highest interest and make significantly larger monthly payments to that debt until it is completely repaid. Then repeat the strategy on the next debt.

If you have a good payment history, you could request that your creditors lower your interest rate. This may lower your monthly payments because much of it goes toward interest. You can also use the strategy of debt consolidation as a time to negotiate a better interest rate with a creditor or take advantage of a promotional interest rate. You can also investigate an equity loan to consolidate debt.

Perhaps you can uncover sources of money you can put toward the payment of your debt. Are there any items on your budget you can reduce or eliminate to put toward paying off debt? Do you have any items you could sell? Do you have a retirement fund or life insurance policy you can borrow from to pay off debt?

Make a conscious effort to answer this question whenever you’re making a purchase: “Do I need to buy this item, or do I want to buy this item?” There are things you need to have to survive, such as food, shelter, clothing, transportation, and healthcare. There are things you want to have, but they are not necessary. If you understand the difference, you can decrease the amount of your discretionary income that you spend each month on items you want and spend more on reducing your debt.

Increase your income

There are some things you can do to increase your income. You can find a second job or work as a contractor or freelancer in your spare time. You can put in more hours, or agree to work overtime, at your primary job. You can ask your employer for an increase in your salary or wage. You can investigate training programs or licensing that will increase your skill level and marketability that could qualify you for a new job or an increase in your salary.

If your debt-to-income ratio is lower than 36 percent, congratulations — you might be ready to be a homeowner. If it’s above 43 percent, you can take some steps to strengthen your DTI and achieve your goal of homeownership.

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