What is DTI? Debt-To-Income Ratio Explained

February 16, 2022
What is DTI? Debt-To-Income Ratio Explained | MacAsh

At MacAsh, we want to do everything in our power to make the home buying process smooth. Part of our mission is educating future homebuyers on mortgage and loan requirements, especially terms they might not be completely familiar with, like debt-to-income ratio (DTI).

DTI is a standard component of most loan decisions, and it’s important for borrowers to understand it, especially since it’s a calculation they have some control over.

Defining Debt-To-Income Ratio

Put simply, your debt-to-income ratio is the percentage of your monthly gross income that contributes to paying your monthly debts or financial obligations. A lender will use your DTI to determine your borrowing risk.

On a fundamental level, the higher your DTI, the higher your risk to a lender. However, an exceptionally low DTI with minimal credit history can also increase your risk. Every creditor uses DTI differently, but it’s best to keep it on the lower end, showing you have excess income.

Examining the Formula

Figuring out your DTI is simple. First, you add all your monthly debt payments together, including loans, mortgage, credit cards, etc. Then, divide that total by your gross monthly income. The result will yield a decimal, and you multiply it by 100 to get your DTI percentage.

For example: If you have a mortgage payment of $1,200, a car payment of $500, and credit card costs of $300, you have a debt obligation of $2,000 per month. With a pre-tax income of $6,000, you would divide $2,000 by $6,000 for a total of 0.33, or a DTI of 33%.

Looking Over the Limitations

While DTI is a good indicator of how well individuals manage their money monthly, it doesn’t offer a complete examination of their finances. Most creditors will use DTI as a preliminary marker for creditworthiness but take a more thorough review of income and financial records, especially for larger purchases like home loans.

Understanding a Good DTI

When applying for a mortgage, it’s best to have a DTI of 45% or less. Some lenders will accept a higher DTI, and it's worth asking if you fall in that category. But 45% is typically the highest a borrower can have and still get a loan.

Lowering Your DTI

There are two ways to lower your DTI: reduce your recurring debt or increase your monthly income. Paying off debt is often easier than increasing one's income. However, it is possible to improve your DTI by negotiating debt and seeking lower interest rates.

Have Questions?

At MacAsh, we want to do whatever we can to help you get the home of your dreams. Contact our experts for more advice and insight into the home buying process.

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