Acronyms get thrown around a lot in the financial world. But if you’re interested in buying a house, DTI is one that you should know and understand.
Debt-to-Income Ratio (DTI) it is the total of your monthly revolving and installment payments divided by your gross monthly income, says Mike Fecht, regional sales manager of mortgage loans at First National Bank, Omaha.
Your gross monthly income is the money you earn before any taxes or other deductions get taken out.
“DTI is one of the many factors lenders use to determine if a loan will be approved. The DTI is used to determine your ability based on your income and current liabilities to repay the monthly mortgage obligation,” he adds.
In fact, a survey by The Fair Isaac Corporation (FICO) shows that poor debt-to-income ratio is the NO. 1 reason mortgage applications get denied.
What monthly bills get included in determining your DTI?
Some of the biggest debts that get added in that affect your DTI are your rent or house payment; alimony or child support payments unless they will end in less than 6-10 months; auto and other monthly loan payments; and credit card monthly payments.
If someone’s real estate taxes and homeowner’s insurance are escrowed, they become part of the DTI debt. A few other payments included could be time share payments or co-signed loan monthly payments.
What payments are not included in a DTI that might surprise people?
Typically, only revolving and installment debts are included in a person’s DTI. Monthly living expenses such as utilities, entertainment, health or car insurance, groceries, phone bills, child care and cable bills do not get lumped into DTI.
What counts as income in a DTI?
To calculate DTI, income can be wages, salary, tips and bonuses, pension, Social Security, child support and alimony, and other additional income such as investments like rental properties or stock dividends.
What is considered a good DTI?
DTI can be different from lender to lender and for different loan products, but typically, a DTI below 45 percent is acceptable. Some loan products allow for higher DTI, Fecht explains.
“With many lenders (including Freddie and Fannie) using automated underwriting, the home buyer’s entire credit, income, and assets are often taken into account when determining approval,” he states. “If a person’s credit is very good, is making a large down payment, and has liquid assets available after closing, some programs will go as high as 50% or higher on DTI.”
Just this summer, Fannie Mae made it a little easier for people with higher debt to qualify for mortgages by raising the DTI to 50 percent from 45 percent. This could help those with big student loan debt – especially Millennials. Student loans have become the largest source of debt in the U.S. apart from mortgages.
A report by the Federal Reserve showed that fewer home buyers have housing-related debt and, instead, more have taken on auto and student loans.
This is backed up by previous research that student loans have definitely made it harder for younger people to purchase a home. But the research also shows that mortgages still make up 67 percent of debt in the US.
Do some loans ask for a very low DTI?
That typically depends on the overall financial strength of the home buyer. If they have marginal credit scores and are making a very low downpayment, the lender may require a lower DTI, Fecht says.
How can a potential home buyer lower their DTI so they can get a better interest rate or a better loan?
If they have multiple student loans, they can look to consolidate them into one monthly payment that is often lower than the total of the individual payments, he adds. Trying to avoid having a car payment or driving a more affordable car with a lower payment will also help.
Student loan payments and car payments are often the biggest monthly obligations outside of the mortgage.
Here’s an example of a DTI
A home shopper buying a $200,000 home puts 10 percent down and gets a 30-year loan at 4 percent. The monthly mortgage payment (including property taxes, homeowner’s insurance, and mortgage insurance) could be approximately $1,400.
The buyer has a car payment of $500, student loan payments totaling $250, and minimum payments on credit cards totaling $180.
This person’s total obligation adds up to $2,330 a month, says Fecht. His annual salary is $70,000, which is $5,833 per month. His DTI is 39.9 percent, which comes from dividing the total of expenses ($2,330) by the gross monthly income ($5,833).
He suggests that potential home buyers should find a local mortgage professional they can meet in person with to review their income and debts.
“A good professional can assist a potential home buyer in doing things that can improve their DTI and overall credit profile,” he says.