If you’re considering purchasing a home, debt-to-income ratio (DTI) is an important term to familiarize yourself with. Your DTI can ultimately make it easier or harder for you to qualify for a mortgage. So knowing your DTI can help you better understand how you can best move forward into homeownership.
What is debt-to-income ratio?
Your DTI compares the amount of money you spend each month paying off your debts to your monthly gross income. It gives the lenders an idea of how much money you have to put toward your mortgage and what kind of debt you can handle. Lenders want to be sure you can make your monthly house payment, whatever it might be.
Back-end and front-end DTI
There are two types of DTI: back and front end.
Front-end DTI is entirely focused on housing related expenses. It’s calculated by adding your future monthly mortgage payment with mortgage insurance, property taxes, and HOA fees if applicable. That number is then divided by your gross monthly income.
Back-end DTI is the percentage of your monthly gross income that goes toward all additional debts. These debts include anything on your credit report such as student loans, credit card debt, car loans, back taxes, alimony, child support, and personal loans.
Lenders typically look for DTIs lower than 30 percent, though that number and possible exceptions differ from case to case. Higher percentages signal to lenders that your finances are stretched too thin and that you’ll potentially struggle to make your monthly mortgage payments.
How to calculate your DTI
To calculate your DTI, add up all your recurring monthly debt payments. This includes mortgage (if you currently have one), HOA fees, car loan, student loans, child support, and alimony, credit card payments, and any other personal loans. Once you’ve totaled all these expenses, divide that number by your gross monthly income, which is your pre-taxed income. Convert that number to your DTI percentage by multiplying it by 100.
You can improve your DTI by paying off your existing debts or decreasing your monthly housing expenses. Reducing your DTI can help you qualify for a better mortgage rate. And if it’s not possible for you to reduce your DTI in time, a cosigner can always help get you qualified. You’ll just have to be sure your payments are made in full and on time, otherwise your cosigner will share in the consequences.