Debt to Income Ratio: How to determine your DTI and why it is important.
Debt to income ratio (DTI) is infinitely important for handing your finances. Using the ratio is simple, all you need is your total monthly income and the total amount spent on bills (car payments, home mortgage, insurance payments, etc.) to calculate your DTI.
Here is an example of how to use the DTI:
- Monthly income (before taxes): $3,000.
- Total payments for the month: $1,000.
Divide the monthly income of $3000 by $1,000 for monthly expenses to get a percentage of 33%, since $1000 is 33% of $3000.
The debt to income ratio is important for a few different reasons. For one, you can determine if you will have enough money to make your payments each month and not put yourself in debt. A lower debt to income ratio allows you to easily pay bills and put money into savings or have extra money to spend. Make note that the debt to income ratio uses your gross monthly income to calculate the debt to income ratio, so realistically you will be receiving less money per month than the DTI accounts for.
The actual percentage has importance as well. If you want to qualify for a mortgage you will need a 41% or less, but a 36% DTI is considered the ideal amount to have. Studies conducted about mortgage loans suggest that those with a higher DTI are less likely to be able to make their monthly payments. While it is less likely to get a qualified mortgage with a higher debt to income ratio, you may still obtain one from a small creditor. They will still check your DTI, but are allowed to offer a qualified mortgage. Keep in mind that it is likely your lender is a small creditor.
Having a good debt to income ratio does not depend on the amount of money you make per month. Someone who has a low income can have an excellent DTI by practicing good spending habits and managing their finances well per month. On the other hand, someone who have a high income per month can have a bad DTI due to poor spending choices and having more bills, or higher cost bills, than they can afford.
A large lender may still offer a mortgage, even though it may not be a qualified mortgage. Large lenders will rely on good faith and CFBP (Consumer Financial Protection Bureau) rules to determine if you have the ability to pay off the loan. It is also important to keep in mind that different lenders have different standards for debt to income ratios. If one lender will not approve you, then contact other lenders to see if they will approve you with your DTI.
Note: If your DTI is 50% or more it is advised to seek help with your debt management right away. You can pay down your consumer debt or increase down payments to increase your debt to income ratio too.