When applying for a home loan, the lender is going to do some underwriting to see how much the borrowing can pay and borrow. One important metric is the Debt-to-Income Ratio (DTI). This metric depicts how much debt you have versus the income you make. 

 

You can calculate your DTI by adding up your monthly debt payments and dividing that sum by monthly pre-tax income. The better this ratio is, the less debt you have and the less risky are to lend money to. 

 

There are two types of DTI a lender could use, front-end DTI or back-end DTI

 

Front-End DTI Meaning

The debt considered is anything having to do with your housing cost. Monthly mortgage payments, property taxes, homeowners insurance, and any other housing costs like HOA fees. 

 

Back-End DTI Meaning

The debt considered here is more broad, including housing costs, but also credit cards, car loans, student loans, and other debt accounts linked to your FICO. 

This DTI is usually more important to your lender since it provides a better image of your monthly spending. 

 

How to Calculate your Debt-To-Income Ratio

 

Add all debt expenses

For example:

• Credit card payments
• Auto loan payments
• Personal loan payments
• Mortgages costs (if still applicable)

 

Don’t include other one time costs, since this isn’t considered debt. You also want to paint the best picture of your financial standing, so the less debt you have the less risky you are to take on more. 

 

Divide Monthly Payments by your Gross Income

In an example where you have $500 in debt payments, and make $1,500 before taxes, your DTI would be 30%.

 

Review

Based on your DTI you can see how you fare in the eyes of a lender.

 

35% or less

You have a good amount of money left over and would be low risk in terms of acquiring more debt.

 

36% to 49%

You are managing your debt, but you are on the higher end of the DTI ratio. Any rare circumstances or problems could mean trouble for your earnings and your debt would be in jeopardy. 

If you are in this range you may have to show more eligibility or explain how you would handle more debt. 

 

50% and higher

With more than half your income going straight to debt payments, you have less to save, spend, and investment. You may get turned down for financings, and interest rates may be higher to offset the extra perceived risk

 

In Conclusion

This metric paints a financial picture for a lender to see if you can handle more debt, another loan, and how much you can handle. 

You want to have a low DTI, so anything less than 50% gives you most options in terms of a mortgage or new loan. 

It’s important to know this metric for yourself as well, since it can provide insight on what you should do in terms of financing options.