What is DTI, and How Does it Determine Loan Qualification

Your debt-to-income ratio (DTI) is what lenders will use to determine your ability to qualify for a loan.

Although it isn't the only factor in meeting lender requirements, your DTI is a simple calculation that lenders use to determine your ability to qualify for a home loan. Based on exactly what the name implies - the amount of debt you have on a monthly basis versus the amount of monthly income coming in - your debt-to-income ratio is a percentage that reveals to the lender your ability to pay for your mortgage.

How is DTI calculated?

First, determine who will be on the loan. This can be a single individual, spouses, friends, family members, or pretty much anyone who will be contributing to the house payment or accepting the risk, such as a co-signor who may not be occupying the home, but willing to pay for the home if the primary borrower is unable to do so.

You will then add up your total monthly debt payments (for each person on the loan), and divide by your monthly pre-taxed income (gross). This will give you your DTI percentage.

For example, if you and your spouse make a combined total income of $10,000 per month, before taxes, and your total monthly expenditures equal $4,000, then your DTI would be 40%.

The monthly payments you expend, should include regular, required, and recurring minimum payments. This does not include the amount you typically pay or the account balance, but only the minimum payments.

This includes the following examples:

  • Monthly rent or mortgage payment

  • Auto loan payments

  • Student loan payments

  • Credit card payments

  • Other personal loan payments

  • Child or spousal support payments

Expenses not included in your DTI are:

  • Utility costs

  • Health insurance premiums

  • Savings and retirement (401k/IRA) contributions

  • Entertainment costs

  • Food and clothing costs

  • Transportation costs (gas, public transportation)

The lower your DTI, the better. In most cases, lenders will require a DTI that is below 50%, meaning that you are only spending about 50% or less of your monthly gross income on required, recurring, or regular debt.

Although each lender will have specific DTI requirements, typically, FHA loans require a maximum of 57% DTI, USDA loans require less than 41%, VA loans require less than 60%, and conventional loans generally require less than 50% DTI.

How to Lower Your DTI:

The fastest way to lower your debt-to-income ratio is to eliminate monthly payments that you can afford. Starting with the smallest debts, try to pay off your outstanding debt in full, so you no longer have the monthly payment as part of your calculation. This will instantly lower your DTI.

Lowering your debt is one way. Another is to increase your income! This may mean adding a second job, picking up more hours at your current job (if possible), or freelancing so you can add more income to your ratio. But, keep in mind, you'll need to show this additional income is regular and will continue. Otherwise, it's simply a temporary influx and cannot be considered in your DTI.

The last, and least recommended, way to lower your DTI is to add a co-signor or another person to the loan. Keep in mind, it must be someone who already has a low DTI, as well. When adding a co-signor, the lender will calculate each person's DTI. However, if their DTI is comparable or higher than yours, adding them is not going to help you. If their DTI is lower, then it potentially could help you qualify for a larger mortgage or lower interest rate. However, unless it is your spouse, I don't recommend getting a co-signor. What happens if your relationship goes south? It could potentially create a lot of issues when it comes to your home ownership.

The bottom line is it is best if you lower your DTI by eliminating as much debt as possible, not incurring more debt (with the exception of your new house payment), and increasing your income. This will help lower your interest rate, lower your monthly mortgage payment, and open the door to more options when purchasing your new home.

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