What is the Debt-to-Income Ratio - DTI
The debt-to-income (DTI) ratio is a personal finance measure that compares an individual’s debt payment to his or her overall income. The debt-to-income ratio is one way lenders, including mortgage lenders, measure an individual’s ability to manage monthly payment and repay debts. DTI is calculated by dividing total recurring monthly debt by gross monthly income, and it is expressed as a percentage.
Debt-To-Income Ratio (DTI)
BREAKING DOWN Debt-to-Income Ratio - DTI
A low debt-to-income (DTI) ratio demonstrates a good balance between debt and income. Conversely, a high DTI can signal that an individual has too much debt for the amount of income he or she has. According to studies of mortgage loans, borrowers who have lower DTIs are more likely to successfully manage monthly debt payments, so lenders prefer to see low numbers. In general, 43% is the highest DTI a borrower can have and still get qualified for a mortgage.
A debt-to-income ratio smaller than 36%, however, is preferable, with no more than 28% of that debt going towards servicing a mortgage. While the maximum DTI will vary by lender, the lower the number, the better the chances that an individual will be able to get the loan or line of credit he or she wants.
For example, John pays $1,000 each month for his mortgage, $500 for his car loan, and $500 for the rest of his debt each month. Therefore, his total recurring monthly debt equals $2,000 ( $1,000 + $500 + $500). If John’s gross monthly income is $6,000, his DTI would be $2,000 / $6,000 = 0.33, or 33%.
There are two ways to lower debt-to-income: reduce monthly recurring debt and/or increase gross monthly income. Using the above example, if John has the same recurring monthly debt of $2,000 but his gross monthly income increases to $8,000, his DTI would be $2,000 / $8,000 = 0.25, or 25%. Similarly, if John’s income stays the same at $6,000, but he is able to pay off his car loan and reduce his monthly recurring debt payments to $1,500, his DTI would be $1,500 / $6,000 = 0.25, or 25%. If John is able to both reduce his monthly debt payments to $1,500 and increase his gross monthly income to $8,000, his DTI would be $1,500 ÷ $8,000 = 0.1875, or 18.75%.
The DTI ratio can also be used to measure the percentage of income that goes toward housing costs, which for renters is the rent amount and for homeowners is PITI, an acronym for the four parts of a mortgage payment: principal, interest, taxes and insurance.