DTI: More Important Than Your Credit Score?
What is the most important number in determining your ability to get a mortgage? If you’re like most people, “Credit Score” likely came to mind. However, there may be a number used by mortgage companies and banks with even more impact than your credit score: Debt-to-income Ratio or (DTI). Here’s what it is and why it’s so important.
By definition, your debt-to-income ratio is a calculation of your total gross monthly debts or payments divided by your total gross monthly income. DTI is calculated both prior to a mortgage and with a mortgage. This percentage helps lenders determine the kind of borrower you’ll be. The smaller the percentage, the better.
The Breakdown of DTI
Put it this way: Even if you pay your bills on time, have a solid income, and carry a good credit score, the ratio of your monthly expenses and debt requirements to your income is central in the mortgage approval process.
A high debt-to-income ratio suggests you carry too much debt for your income, whereas a low DTI is a good indication that you balance your debt and income well. Lenders are generally able to offer better rates when they see evidence of successful debt management. Due to federal regulations, many lenders aim for a maximum DTI of 43%. A good DTI ratio is in the 30 percent range.
How to Calculate Your DTI
Easily! To determine your DTI, add up your recurring monthly debt payments and divide them by your gross monthly income (before taxes and deductions).
For example: If you pay $1,000 a month for your mortgage, $300 a month for your car loan, $200 a month for your student loan, and $300 a month for the rest of your monthly debts, then your recurring monthly debt is $1,800. If your gross monthly income is $5,000, then your DTI would be $1,800 ÷ $5,000 = 0.36 or 36%.
With a 36% DTI, you’re still in a good spot to be a borrower.
Improving Your DTI
So your mortgage application was in the underwriting process, but there was a hang up: Your DTI was too high. It’s not the end of the world. You can lower your DTI by:
- Paying off debt: The more monthly debt you can eliminate, the lower your DTI will become. Close to paying off your car or student loan? If your finances can handle it, pay them off early and get rid of these monthly payments once and for all!
- Increasing your salary: This doesn’t happen with the snap of your figures, but have you considered a new position at your company, asking for more hours, or learning new skills?
If possible, adding a co-borrower or co-signer to the loan who has a lower DTI than yours might bring your combined DTI down to an acceptable level.