When you’re buying a house, certain numbers – like your Debt-To-Income (DTI) ratio – are a big deal. But what is a Debt-To-Income (DTI) ratio, and why do lenders look at it when evaluating you for a mortgage?
Let’s start by briefly talking about what DTI reflects.
What is a Debt-to-Income Ratio?
Your Debt-To-Income ratio is actually a fairly simple calculation. It’s where you divide your monthly debts by your monthly gross income. The equation looks like this:
Monthly Debts/Monthly Income
To make this more real, let’s use some made-up numbers.
Let’s pretend that right now your job pays you $60K per year. Divided by 12, that means you make $5,000 a month in income. You also have a side hustle that nets $500 per month, so you end up at $5,500 per month.
You have a few bills:
- You want to buy a house that will cost $1,500 per month
- You have a car payment of $230 per month
- Your student loans cost another $200 per month
That brings your total recurring payments to $1,500 + $230 + $200 = $1,930 every month.
To get your DTI, divide $1,930/$5,500 = 0.35, or 35%.
Great – now we have the DTI. But what does that number mean? Is 35% good, bad, etc.?
What is a Good Debt-to-Income Ratio?
Each lender is different, but there are a few numbers generally used in the mortgage space around DTI.
When we talk about a “good” DTI, it generally means the ratio is under 36%. In the case we mentioned above, you’re in the clear since the ratio is just 35%.
That said – there is a risk to it. If you lost your side hustle – or the lender didn’t want to consider it as regular income – your new ratio is $1,930/$5,000 = 0.386, or 38.6%. Now you’re over that 36% threshold.
The good news is you’re still okay. You may not get the best interest rate available, but you can still probably qualify for a mortgage.
The number typically used as the ceiling is 43%. But that doesn’t mean you will not be approved once you pass the barrier.
Let’s jump back to our example. Let’s say you wanted to buy a more expensive house and now your monthly payment would be $1,900. On top of that, the lender doesn’t want to account for your side hustle. That means your monthly debts are $1,900 + 230 + 200 = $2,330 per month.
Now your DTI is $2,330/$5,000 = 46.6%. This DTI of 46.6% is on the higher side, but the good part is SWMC has no overlays related to DTI which means, we can allow DTI as long as Automated Underwriting System (AUS) gives the approval.
How to Improve Your Debt-to-Income Ratio
Since there are two numbers that factor into your ratio, you can impact the ratio by changing either number.
Option #1: You can make more money
Option #2: You can reduce debts
Depending on your situation, one may be easier than the other. In the case of our example, your easiest option may be to just buy a less expensive house. If you drop your payment back down to $1,500 a month, the DTI gets into a favorable range. Even if you settled in the middle for
about $1,700 a month, you’re still less than 43% for your DTI.
If you really want that house, maybe you can do something to make more money. If you bump your income to $6,000 a month, now your DTI is $2,330/$6,000 = 38.8%, so now you can probably qualify.
Do you have any questions about your Debt-To-Income ratio? Give us a call at (844) 765-6844! We look forward to hearing from you.