Your debt-to-income ratio (or "DTI") is a number lenders use to help them decide if you can repay a loan. Lenders typically look at your debt-to-income ratio and other financial factors before they decide to offer you a mortgage to buy a house. They may check your DTI before they offer you a mortgage to refinance a house you currently own too.
How debt-to-income ratio is calculated
Debt-to-income ratio is calculated using a simple formula. Take the total of your monthly debt payments, divide this total by your monthly income, and express the result as a percentage. Look at these examples:
|Total Monthly Debt Payments||Monthly Gross Income||Debt-to-Income Ratio (numeric)||Debt-to-Income Ratio (%)|
You should count all debts toward your total monthly debt payments. Include rent and mortgage, credit card, auto loan, student loan, insurance, child support, and alimony payments in your total. Your monthly gross income may include wages earned, plus tips and bonuses if applicable, social security income and pension payments, child support and alimony. Once you have these totals, divide your total monthly debt payments by your monthly gross income to calculate your debt-to-income ratio.
Why debt-to-income ratio is important
Debt-to-income ratio is one way lenders estimate the risk of offering people loans. Lenders may consider people with higher debt-to-income ratios more risky than people with lower debt-to-income ratios. That's because people with higher DTIs may have less money available to deal with an unexpected expense like a car repair or medical bill, which might affect their ability to make their monthly loan payments.
People with lower debt-to-income ratios might have more money to pay for unexpected expenses. As a result, having a lower DTI can make borrowers more attractive to lenders and may improve their chances of getting approved for a mortgage or refinance.
What is a good debt-to-income ratio
Debt-to-income ratio requirements can vary by lender and by loan type. Some lenders may accept a higher DTI than others, and most lenders look at a variety of financial factors besides your debt-to-income ratio before they decide to offer you a loan.
Financial professionals often recommend keeping your debt-to-income ratio under 36%. This is the number Fannie Mae uses as a maximum DTI for many of its loans1. The Consumer Financial Protection Bureau notes that most borrowers can have a debt-to-income ratio no greater than 43% if they want to get a qualified mortgage2.
Debt-to-income ratio and how much house you can afford
Your debt-to-income ratio can have an impact on how much house you can afford because DTI may affect how much money a lender might be willing to let you borrow. If you start with a higher debt-to-income ratio, lenders may be willing to loan you less money than they would if you have a lower DTI.
Would you like to learn more about how much money you may be able to borrow to buy a home? Visit our Get Started page or call one of Freedom Mortgage's friendly loan advisors at 877-220-5533.