Those of us in the mortgage and real estate industry often throw around acronyms. At times, it can be a veritable alphabet soup. I often catch myself rattling off things like APR, FHA, and HUD as if everyone around me knows exactly what I’m speaking about.
While many of the times I mention these acronyms, I should simply be ignored, some of them have important meanings—meanings of which everyone should at least have a basic knowledge. One such important acronym is DTI which stands for Debt-To-Income. This article will explain what DTI is, and why it’s important in determining how much mortgage financing you might receive.
What Is DTI?
DTI (or Debt-To-Income) is the ratio of your debt to the amount of gross income you make on a monthly basis. The type of debt that’s included when computing your DTI can vary depending on what it’s used for, but for the purposes of getting a mortgage, it includes any installment debt such as student loans, car payments, and credit cards as well as any current or proposed mortgage payments (taxes and hazard insurance included).
There are also two DTI calculations, one for the mortgage only (called the front-end DTI) and one for the mortgage and other accounts (called the back-end DTI). As an example, let’s say your gross monthly income is $5,000. Your proposed new mortgage payment is $1,500 and you have existing debt payments of $500. With these numbers, you could easily compute your front-end and back-end DTI. Your front-end is ( $1,500 / $5,000) 30 percent and your back-end is ( $1,500 + $500 / $1,500 ) 40 percent.
Why Is DTI So Important?
Your Debt-To-Income ratio is important because it is one of the main factors that determines how much money you can borrow. Each type of loan you might apply for has its own requirements for your DTI. As a general rule, a borrower should have DTI ratios lower than 36 percent and 45 percent, respectively. With these requirements in mind, it’s easy to see that the more existing debt you have, the smaller amount of financing you could qualify for and the less existing debt you have, the greater amount financing you could qualify for.
My Recommendations for Your DTI
Here are my recommendations for maintaining a healthy DTI. These recommendations become HARD AND FAST RULES when you are actually trying to qualify for financing.
- Keep credit cards paid down so your monthly payment is low to zero.
- Do not take on any unnecessary financing (such as a car loan or personal loan).
- Check your credit report periodically to ensure that all the information being reported is accurate and complete.