Your debt-to-income (DTI) ratio is a crucial factor lenders consider when evaluating your mortgage application. This number compares your monthly debt payments to your gross monthly income, providing insight into your financial health and ability to manage mortgage payments. Simply put: Lenders use your DTI ratio to determine your borrowing risk. Here's what to know about how your DTI ratio is calculated, and what you can do to put yourself in the best possible lending position.
How to calculate your DTI ratio (and why you should)
A debt-to-income ratio is calculated by dividing your total monthly debt payments by your gross monthly income (aka before taxes). For example, if your monthly debts total $2,000 and your gross monthly income is $6,000, your DTI ratio would be 33% ($2,000 / $6,000 = 0.33).
The main purpose of calculating your DTI ratio is risk assessment. Where your credit score tells lenders how you've managed loan payments in the past, your DTI tells lenders if you have enough money currently available to pay back a loan going forward. A lower DTI suggests you're more likely to manage your mortgage payments successfully. Not only can a lower DTI ratio increase your chances of mortgage approval, but even help you qualify you for better interest rates and loan terms.
Ideal DTI ratios for mortgages
According to the Consumer Finance Protection Bureau, 43% is typically the highest DTI ratio a borrower can have and still qualify for a mortgage. However, lenders tend to prefer a DTI ratio lower than 36%. Ideally, no more than 28%–35% of your total income should go toward servicing a mortgage.
Tips to improve your DTI ratio
If your DTI is higher than desired, it might not be the best time to apply for a mortgage. There's no easy hack here: Your best bet is to pay down your existing debts. Consider asking creditors to reduce your interest rate, which would lead to savings that you could use to pay down debt. Similarly, boosting your income would also improve your DTI ratio. If you're focused on improving your number, hold off on applying for any new credit or loans, since this would negatively impact your DTI ratio.
Remember, while DTI is important, it's not a dealbreaker until you're up around 43%. It's just one factor lenders consider, while elements like your credit score, employment history, and down payment play more significant roles in the mortgage approval process.
For more insight into the navigating the home-buying process, check out my "How We Bought Our First Home" series here. And if you'd like to share your experiences buying your first home, drop a comment below. Maybe you can help paint a wider portrait of what it looks like to navigate the housing market these days—particularly without generational wealth.
