If you are purchasing a home using financing, you will likely hear the term DTI from your lender.
DTI stands for Debt-to-Income ratio, and it’s one of the main factors lenders consider when evaluating a borrower’s ability to repay a mortgage. Essentially, the DTI ratio measures the percentage of a borrower’s monthly gross income that goes toward paying their monthly debts.
The calculation of the DTI ratio is straightforward. First, the lender adds up all the borrower’s monthly debts, including credit card payments, car loans, student loans, and any other monthly obligations. Then, the lender divides this sum by the borrower’s gross monthly income, which is the income before taxes and other deductions are taken out.
For example, suppose a borrower has a monthly income of $5,000 and pays $1,500 in monthly debts. In that case, their DTI ratio would be 30% (1,500 / 5,000 = 0.3, which is 30% expressed as a percentage).
The DTI ratio is important to lenders because it provides a reliable indicator of the borrower’s ability to repay a mortgage. A high DTI ratio indicates that a borrower has a significant amount of monthly debt compared to their income, which may suggest that they could have difficulty making mortgage payments on time.
Lenders typically have different maximum DTI ratio requirements, but in general, a ratio of 43% or lower is preferred. However, some lenders may accept higher DTI ratios if the borrower has a good credit score, a history of consistent payments, and a substantial down payment.
To improve their DTI ratio, borrowers can take several steps. These include paying off high-interest debt, such as credit card balances, and reducing monthly expenses. Additionally, borrowers may consider increasing their income by taking on additional work or requesting a raise from their current employer.