When it comes to getting a mortgage, many people think their credit score is the most important number associated with their name. While a person’s credit score is important, along with how much money they have saved, there’s another number that is just as important: debt-to-income (DTI) ratio.
A DTI ratio is one of the ways lenders measure your ability to make payments toward money you’ve borrowed. Your DTI ratio is expressed as a percentage and is comprised of your total minimum monthly debt divided by your gross monthly income. Your total minimum monthly debt is made up of your minimum monthly payments for car loans, student loans, credit card debt, home equity loans, mortgages, and any other recurring debt you might have.
When you’re in the market for a mortgage, it’s imperative that you know your DTI. To calculate it, you must take into account all of your monthly debt payments and divide the total by your gross monthly income (the amount of money you earn before taxes). For example, if you pay $1,500 a month for your mortgage, $100 a month for an auto loan and $400 a month for the rest of your debts, you pay a total of $2,000 per month toward debts. If your gross monthly income is $6,000, then your DTI ratio is 33%.
It’s important to remember that your minimum monthly debt is the minimum you are required to pay each month. For example, if you owe $3,000 on a high-interest credit card, and your minimum payment on that specific card is $150, only that $150 is going to figure into your DTI. Keep in mind, however, that paying only the minimum amount on your debts can make them grow larger.
A good rule of thumb is the lower your DTI, the better. A DTI less than 50% is generally considered workable in the mortgage industry. However, if your DTI is higher than 50%, you may have a difficult time qualifying for a mortgage. If your DTI is 20% or lower, you’ll be able to borrow more and have more options than someone with a higher DTI.
If your DTI isn’t to your liking, you’ve got two options, both of which are easier said than done. Your first option is to increase your income so you have more money to work with. Your second option is to reduce your debts to enable your existing income to go further. For the second option, focus on paying off your credit cards and other loans, and avoid taking on additional debts.
If you’re in the market for a new mortgage, don’t overlook your DTI. Many people assume that if they have a good credit score and good income, getting a mortgage will be no problem. The fact is that a good DTI also has a huge impact on getting you qualified for a mortgage.
We want to hear from you now! What questions do you have about DTI? Has a high DTI prevented you from qualifying for a mortgage? If so, how did you lower it? Let us know in the comments below!
If so, subscribe now for tips on home, money, and life delivered straight to your inbox.