Definition
The Debt-to-Income Ratio (DTI) is a financial metric used by mortgage lenders to assess a borrower’s ability to repay a loan. It measures the percentage of a borrower’s gross monthly income that goes toward monthly debt obligations, including mortgage payments, credit cards, car loans, and other debts.
Explanation
DTI is a key factor in mortgage approval because it helps lenders determine if a borrower can afford a home loan without becoming financially overextended. A lower DTI ratio indicates financial stability, while a higher DTI suggests the borrower may struggle with additional debt.
The formula for calculating DTI Ratio:
DTI=(Total Monthly Debt Payments / Gross Monthly Income)×100
Types of DTI Ratios:
- Front-End DTI (Housing Ratio) – The percentage of income spent on housing costs (mortgage, taxes, insurance, HOA fees).
- Back-End DTI – The percentage of income spent on all debts, including housing, auto loans, student loans, and credit cards.
DTI Limits for Mortgage Approval:
- Conventional Loans: Usually 43% or lower.
- FHA Loans: Can allow up to 50% with strong credit.
- VA Loans: Typically 41%, but flexible.
- Jumbo Loans: Stricter limits, often under 40%.
Example
A borrower earns $6,000 per month and has the following debts:
- Mortgage payment: $1,800
- Car loan: $400
- Credit card minimum payment: $200
- Student loan: $300
DTI=(1,800+400+200+300/6,000)×100
DTI=(2,700/6,000)×100=45%
Since 45% is on the higher end, the borrower may need to lower debt or apply for an FHA loan instead of a conventional loan.