Most people think about credit scores when they’re getting ready to apply for a mortgage. But there’s another number that’s every bit as important as your credit score, although it’s not something people think about very often. This is your debt-to-income ratio, or DTI, and I’m going to tell everything you need to know about it.
What is DTI?
Exactly what is DTI? It’s the calculation of all of your monthly debts (these are also called recurring debts) divided by your gross monthly income.
Your gross monthly income includes annual income for both you and the person taking out a loan with you, if applicable. It can sometimes include tips, commissions, overtime pay, bonuses, investment income, child support, or alimony, depending on how stable the income is and how long you’ve been receiving it.
Your gross monthly income includes everything you earn before federal and state taxes or any other deductions.
Recurring monthly debts include:
- Mortgage or rent payments
- Minimum monthly credit card payments
- Payments for leased or financed cars
- Other loan obligations, including student loans, child support, alimony, rental property maintenance, or any other personal loans that you pay periodically
Two DTI Calculations
A front-end ratio (or housing ratio) calculates the percentage of your income that would be going toward housing expenses with your new monthly mortgage payment, taxes, insurance, and any HOA dues (if applicable). The ideal front-end ratio is no more than 28% but it should be at least 36% or lower.
The back-end ratio shows what portion of your income covers all of your monthly debt obligations. As mentioned earlier, this is your monthly debts divided by your monthly gross income.
For conventional loans, most lenders focus on back-end ratio rather than the front-end ratio.
What is a good DTI?
The smaller your DTI is, the less risk you represent to potential lenders. Even if you always pay your bills on time, have a great credit score, and have a really good income, lenders will still care about how much debt you carry.
If you have too much debt for your income, lenders will be concerned that you don’t know how to balance your debt. This is why DTI limits exist—to make sure you don’t take on debt that you really can’t afford.
With us, you can’t go above a DTI of 43% to 45%, depending on the loan (this is standard with most lenders). A good DTI ratio is about 30%, and 20% or below is excellent. There are sometimes compensating factors like a good credit score, a low front-end ratio, and money you still have in savings after the down payment and closing costs.
What if your DTI needs improvement?
You’ve got a few options if your DTI needs improvement.
- Pay off debt
- Increase your salary getting a promotion, or taking on another job, or getting more hours (but this only works if the employer is willing to state that this incresed income will continue). In other words, you can’t pick up more hours just to get a mortgage and then stop working those hours afterwards.
- Ask a relative to co-sign your mortgage, but only if they have good income and good credit
Last, it might be a good idea to just wait before you add a mortgage to your monthly mix of bills. If your debt load is too great, a mortgage could be a really unwise idea. You may want to wait until you’re in a better financial position to buy a home.
If you need any help figuring out your DTI or what it might mean for your mortgage application, give us a call at (503) 528-9800. We’ll be happy to help you and answer any questions you have.