The ideal debt-to-income ratio

The DTI or debt to income ratio is a term used to define the level of debt that a person has as compared to his/her monthly gross income. The debt includes all the monthly payments such as credit card bills, loan payments, etc. It does not include daily items like gas or groceries, etc. The income includes his/her monthly income before varied deductions like taxes, etc.

Lenders generally use the DTI ratio before approving consumer loans. It may also be used by loan officers and home loan underwriters. It is however not used by credit card companies at the time of issuing credit cards to customers.

Lenders use the DTI ratio to verify the ability of a prospective borrower to repay a loan. By using the ratio, lenders verify for certainty whether or not the borrower will hustle to gather the money every month to make the loan payments. The chances of the borrower scrambling for money are higher if the DTI ratio is higher as opposed to a lower debt to income ratio.

Lenders use a prospective borrower’s monthly gross income and his/her debt payments each month to calculate the exact DTI ratio. Thus for example, if the gross monthly income of an applicant is $5000 and his/her monthly debt payments are $1000, then the debt to income ratio is 1000/5000 = 0.2 or 20 percent. A debt to income ratio of 20 percent is considered as good by lenders.

The gross monthly income of a person refers to the income that he/she receives before subtraction of state and federal taxes as well as other kinds of deductions. It does not refer to the amount of money that a person takes home as income.

The different items of debt that lenders take into consideration whilst calculating the debt to income ratio include mortgage loan payments, student loan, minimum payments for credit cards, auto loan payments, alimony payments, child support payments, personal loan payments, and other kinds of monthly recurring loans/bills.

It may also be noted that there are many DTI ratio calculators and apps that are available for use online.

The DTI and Home loans (mortgage)

Lenders often use the DTI ratio to calculate the monthly mortgage loan payments and the home loan rates.

With regards to DTI ratios, mortgage loan lenders use a 28/36 rule when determining a borrower’s ability to repay the loan.

The number 28 refers to the home expenditures of a borrower. Home expenses (which include property taxes, homeowner’s insurance, flood insurance, private mortgage insurance/ PMI, and house owner’s association fees, etc.) cannot be more than 28 percent.

The number 36 refers to a borrower’s debt to income ratio. Thus, the DTI of the borrower should ideally be not more than 36 percent when applying for a mortgage loan.

The maximum DTI allowed by mortgage loan lenders is 45 percent. A DTI of 18 percent is regarded as excellent. Extra expenses associated with the mortgage loan are dependent on the bank or the financial institution that a borrower approaches for the loan.