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What’s a Good Debt-To-Income Ratio?

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You’ll see the term debt-to-income ratio a fair amount if you’re applying for a mortgage. Debt-to-income ratio is also known as DTI.

This is a measure of your monthly debt payments divided by your gross monthly income.

Lenders use DTI and your credit history to determine whether or not you can repay a loan. Every lender will have its own DTI requirement.

Calculating Your DTI

A lender wants to see a low DTI because this shows them that you’re more likely to be able to manage your monthly payments successfully.

When you have a low debt-to-income ratio, it’s a healthy balance between your debt and how much you’re making. The lower this percentage, the higher the chances you’ll get a loan or line of credit.

If you have a high ratio, it shows a lender that your debt is already too high compared to your income, which could be a red flag you shouldn’t take on more obligations financially.

To calculate your DTI, you should add your total monthly obligations that are recurring. These obligations can include mortgage and student loans, car loans, credit card payments, and child support. Then you divide this by your gross monthly income.

Your gross monthly income is the amount you earn every month before taxes and deductions.

How Does DTI Affect Getting a Mortgage?

Lenders want a broad, comprehensive view of your finances when you apply for a mortgage. When you apply, they’re going to look at your DTI primarily to decide whether or not to approve you and figure out how much you can afford to pay for a house.

Lenders also look at your credit history, your money for a down payment, and your gross monthly income.

What DTI Does a Lender Want to See?

While every lender is different, most lenders want a DTI ratio smaller than 36%. They want to see that no more than 28% of your debt will go toward servicing your mortgage.

If you have a gross income of $5,000 a month, the maximum amount you could put toward mortgage payments would be around $1,400 a month in the eyes of most lenders.

Lenders also assess your total debts, which shouldn’t be more than 36%, so again, if you were making a gross income of $5,000 a month, that would be around $1,800.

In most cases, 43% is the highest ratio you can have as a borrower and still get a qualified mortgage. Otherwise, if your number is above that, your lender will probably deny your application because your expenses each month would be seen as too high compared to your income.

Your debt-to-income ratio doesn’t affect your credit score, and your income isn’t included in calculations that credit-reporting companies do.

What does count toward your credit score is another ratio—credit utilization. This is the amount of credit you use compared to your limits.

Credit reporting agencies know your credit limits on individual cards and total. You should aim to keep the balances on your cards at no more than 30% of your credit limit. Lower is always better here.

Summing Up

Your DTI gives lenders an idea of how you manage debt and if you have too much. If your DTI is less than 36%, your debt is considered manageable relative to your income, and at least based on this factor, you should be able to access new lines of credit.

If your DTI is between 36%-42%, lenders might be concerned about lending you money. If your DTI is 43%-50%, creditors might deny applications. You should focus on paying off the debt before applying for something like a mortgage.

If your DTI is higher than 50%, you might consider debt relief options.

Written by Ashley Sutphin for Copyright © 2023 Realty Times All Rights Reserved.