Your debt-to-income ratio, or “DTI,” can have a profound impact on your mortgage. A good DTI can result in better terms for your loan, while a high DTI can increase interest and even cause a rejection of your application.
So what counts as as good? To answer that question, you need to first understand the basics of DTI and why it’s important to lenders.
What is DTI?
Debt-to-income ratio is simply a comparison of your monthly debts vs your monthly income. Suppose you have a monthly debt total of $2,000 and a monthly income of $8,000. In this scenario, your ratio would be 25%. ($2,000 is 25% of $8,000.) However, if your debt payments were to increase to $4,000, your DTI would now be 50%.
It’s important to remember that the ratio only considers your current monthly debt payments, not your debt total. So, essentially, if two borrowers both have $2,000 in debt payments and $8,000 in monthly incomes, but one has a debt total of $50,000 and the other a total of $100,000, the debt-to-income is still 25%. (Totals can impact other factors, but your DIT remains the same.) This little fact can be helpful if you are trying to lower your DTI, which we will discuss in detail below.
Why is DTI Important to Lenders?
Your debt-to-income ratio is an important indicator of your ability to take on new debt. If your DTI is relatively high, adding another loan, especially a mortgage which is often the largest debt payment, can make it hard for you to maintain monthly payments. A high DTI, simply put, creates more risk.
Front End vs Backend DTI
There are two types of debt ratios that you should understand: frontend and backend. These two ratios are calculated in a slightly different manner.
Frontend
Frontend DTI is the most simple. This is simply a comparison of the proposed mortgage and housing costs, which can include P&I, taxes, HOA dues, and insurance, against your income. It is simply a comparison of the mortgage and housing total against your income, and does not include other payments like credit cards, student loans, and car loans.
Backend
Taking a deeper dive into your finances, backend DTI is a bit more complex. It takes a little more research, and just a few more calculations, to find your backend DTI. However, it’s still fairly simple. With backend DTI, your entire debt total is considered.
Pretty much all types of loans, from auto loans to student loans to personal loans, are included. Court-ordered payments, such as child support, can also be part of these calculations, but one-time expenses, such as medical bills, are not.
The lower your debt-to-income ratio, the better. However, there are mortgage programs that have different requirements for both frontend and backend DTI.
Frontend
Lenders generally prefer your frontend ratio to be somewhere around or below 30%. With this ratio, less than a third of your income is going to the mortgage, which gives plenty of financial breathing room. If there is a decline in income, for example, someone with a ratio of 25% is probably able to get by, while someone with a DTI of 50% will have more difficulty.
Backend DTI
For backend DTI, you can likely expect a cap around 45%. In other words, many lenders and loan programs only allow backend DTIs to go as high as 45%; if your ratio is 46%, you may not qualify.
Generally, backend DTI can be separated into these ranges:
35% or Lower: The Ideal DTI
With a backend DTI of 35% or less, you are well-positioned to take on new debts. Your monthly income will not be consumed by the mortgage, leaving plenty of wiggle room in your budget. You’ll have plenty of cash left over after paying the bills, so savings (and spending) won’t be a problem. For loans, you’ll probably qualify for the best terms, assuming other factors, like the credit score and downpayment, are good. With a low DIT, lenders see you as a nearly risk-free borrower.
36% to 49%: Not Bad, But Could Improve
In this range, you are managing your debt well, but there is still room for improvement. You may not get the best possible terms, and you could, depending on the lender and the program, get a higher interest rate compared to someone with a lower DTI. However, you will almost certainly qualify for a high-quality loan.
50% or More: Tight Budget Means Fewer Loan Options
When your DTI goes beyond 50%, your monthly budget becomes stretched. Half or more of your income is going to debt payments, which means you have less room for spending and saving. A financial loss would create massive issues for your finances. With ratios above 50%, you are far less likely to qualify for a loan. You’ll have fewer loan options available, and the loans that you can access may have less-than-ideal terms.
The ideal ratio is different for each borrower, each lender, and each loan program. However, we can say that the lower your debt load, the better chance you have for securing a top-quality mortgage.
Can You Improve Your DTI?
If you have a DTI over 50%, or if you’re between 36 and 49% and simply want to improve your budget or mortgage terms, there are options. Basically, you can do two things: lower your monthly debts or increase your income.
Paying off debts is one of the best ways to quickly improve your DTI, but not everyone has the cash. Refinancing or consolidating your loans, however, could result in a lower payment. Perhaps you can get a longer loan, pay off high-interest loans, and enjoy a lower payment even if your debt balance stays the same. This would lower your DTI, as only the monthly obligations, not the total balance, is considered.
Of course, you could also take on a second job, start a from-home business, work more hours, or request a pay increase. All of these would enhance your earnings and lower your debt-to-income ratio.
Is Your Ratio Too High? Our Team Can Help
Have you been rejected for a loan because of your DTI? Contact our team and we’ll use our experience and knowledge to find a mortgage that fits your specific needs!
