Your Debt To Income Ratio: How To Figure It Out

Certified Mortgage Advisor
NMLS 1701021
February 9, 2020

DTI and how it affects your mortgage qualification

Today, we're talking about understanding your debt to income ratio. Your debt-income-ratio is one of the biggest factors in if you're going to qualify for a mortgage.

Who determines your budget?

Now, a quick side note here is your debt-to-income ratio is doing nothing to help you understand if a mortgage is going to be beneficial for your budget, you are the one who determines your budget.

DTI and Credit Score, why are they important?

What we're going to talk about is how much you can qualify for with a mortgage. And it's probably a bit more than you think. The debt-to-income ratio is one of the biggest factors along with the credit score if you're going to be able to qualify for a mortgage.

What is DTI

Different loans have different maximums for your debt-to-income ratio. So your debt-to-income ratio is you take your monthly debt obligations, how much you pay per month. Plus your future housing expense is divided by your gross income. That's going to give you your debt-to-income ratio and you need that number to be below maximums.

Why do we care about the debt-to-income?

Because it is one of the biggest factors in qualifying for a loan. If you have a debt-to-income ratio, that's too high, then you either need it. Somebody like a co-borrower on your loan, you need to pay down debt, or you're not going to be able to qualify for a loan. There's no way to get a mortgage. If your debt-to-income is too high.

What lenders don't want to see

A lender doesn't want to give you money. If they already see that you have a lot of debt that you're paying on and you might struggle to pay on the mortgage. And that's the big thing that the debt-to-income ratio tells a lender is can you pay this loan back?

ATR Rule

It's based on a rule called the Ability to Repay rule or ATR rule. The basically says lenders have an obligation to make sure that you have some financial capacity to pay back this loan.

Could, not should

Also, that's income is telling you what you could borrow, not what you should borrow. So for a lot of people, they're going to see that they can qualify for a lot more and more courage than they probably should take on.

It's you, not the bank or anyone else

And here's the deal is you are ultimately the one responsible for your budget, not the bank. I see this a lot where people say, I can't believe the bank would let me get this money that's saying that they would lend me this amount of money. What the bank is lending you is based on statistical risk factors of who defaults on loans and who doesn't.

So if a bank is willing to give you money, then statistically you're likely to not default on your loan, but you are ultimately responsible for your budget. If you're going to take out a loan, you take responsibility for the loan. No one forced you to take it. So if you can't afford the loan, if you don't understand everything that's going on, and then you struggle with it later, that's not the bank's fault. You are responsible for this.

Know your budget

You need to know your budget before you go into purchasing a home to see if you can afford it because not only are you going to keep in mind your principle and interest payment on the loan, but you also need homeowners insurance and taxes, maybe homeowner association fees.

You also need to calculate utilities any long-term maintenance expenses on the house. Even repair costs, if you need that on your home as well, make sure that you know your budget before you go into understanding these numbers a little bit more.

Let's calculate DTI

Now let's talk about how do we actually calculate our debt to income ratio. Your debt-to-income ratio is solved by doing this. You take your total monthly debt payments divided by your gross monthly income.

How to get Gross Monthly Income

So first the easiest thing to figure out is your gross monthly income. One of the harder things to figure out is what are your total monthly debts? Okay, so we're going to separate your total debt. Your total monthly debts are your current debts plus your future housing payment.

What's in debts?

So let's run through an example of things that might be in debts. In your debts would be things like student loans. Any auto loans, auto leases any type of credit cards, any current mortgages that you have right now, those are debts. These debts are things that are collected over a period of time that you're required to pay back.

What's not included in your debts?

What's not included in debts are things like insurance or utilities. Those are things that you can stop. Those are expenses. They're not things that get collected over a long period of time. You can stop them whenever you want. You might not have the service. But you're allowed to stop them legally that's you can't stop paying on them without getting into some trouble with those accounts.

Two things that stick onto debts

The two things that do stick onto debts that are not technical debts are child support and alimony. Those need to be calculated in.

An example computation

So let's run through an example of what an example of debt to income ratio might look like. So let's say I have a $400 car loan per month. So I pay a minimum of $400 per month. And what you're interested in on your debt to income ratio is not if you overpay. So if you, if I paid $600 a month in this car, I'm only going to use 400, the minimum payment. So $400 a month, car loan, maybe I have a hundred dollars on a credit card.

So I pay a hundred dollars a month on that. Then maybe I pay an additional, let's say $500 in child support. We're going to throw that example in there as well. So I have these debts, plus let's say I'm looking at buying a house and I want to put in the full payment of that home here because this is what I'm trying to qualify for on my debt-to-income ratio.

So let's say that my house is $800 in principal and interest, and it's an additional $200 in taxes and $60 in insurance. So this is my total P I T I payment or Principal Interest, Taxes, and Insurance. So I need to add these together to get my total debt. So my total debt payments per month are $1,560. That is the total minimum debt payments that I would make per month.

How to get the DTI?

So then to figure out our debt to income ratio is we take the total debt payment per month total which is $1,560 divided by our gross income.

Why gross, not net income?

Now some people ask, why would we use gross income? The reason lenders use gross income instead of your take-home pay is that the gross income or before-tax income is the easiest metric to use because people have different types of withholdings in their paycheck.

So somebody might have a paycheck, but they get their 401k taken out of it and they have other expenses taken out of it. And so net pay or what you get as take-home pay isn't a fair assessment of how much you actually make your actual earning potential or gross income is. So everything's based on your gross income.

So let's say in this scenario that our gross income is $5,000 per month. So then what we do is retake $1,560 divided by 5,000. So that gives us a 3.1, 2% debt-to-income ratio. So now what we do, now that we know the flow of how everything goes, what we're really trying to do with our debt to income ratio is figure out this figure our DTI percentage.

Because most of the time we already know what our debts are. We know what our income is, but we're trying to see how much can we qualify for, and we have to do a little bit of reverse math to get there and we will also talk about debt-to-income limits.

How much can we qualify for?

But for now, let's say that we want our debt-to-income ratio to be a max of 43%. Our goal is a 43% debt-to-income ratio. So we want our total debts to be 43% of our total gross income. So let's say that our income let's use five grand per month. So we know that if we want 43% of our income to be debt as a maximum, what we're going to do is we're going to take 5,000 and multiply it to 0.43. Now, the product is $2,150 which is your Max Debt. That's the maximum amount of debt I can have for my income because that's 43% of $5,000.

So you could do the same thing with your income. Find what your gross income is per month. And you can do this by looking at last year's W2 and dividing it by 12, or look at what you've been consistently making as your gross income per month. Multiply that times 0.4, three, and then you're going to find the max debt you can have. So this max debt is the same thing as total debt.

Let's figure out our debts

So now what we need to do is we need to list out our debts. Let's say, we have a $400 per month car and a $200 per month credit card. And let's say we have maybe no other debt other than that. So we have a total of $600 in these debts.

How much house can we afford?

Now what we need to do is we need to figure out how much house can we afford. Because we don't know this number yet. We're trying to figure out what's our max amount. So what I can do is I can take $2,150 and subtract 600 from it, and I can see that the max housing payment I can have here is $1,550. Because if we do that math again, we can take $1,550 plus 600. And that gives us $2,150, which is our max total debt.

So you can do the same thing as well. You're going to list out your debts. But what your goal is for your debt-to-income, what your income is monthly, and then the total max debt you can have, and then just subtract to figure out what this future housing payment can be. Now, the most you can take on is a $1,500 per month housing payment, and that's your principal, your interest, your taxes, and your insurance.

What is your DTI ratio limits?

So now that we know that what are the actual debts-to-income ratio limits, cause the debt-to-income ratio doesn't really tell us much other than what percentage of our income is debt. When you're using different loans have different income limits.

Conventional Loans

They are 49.9, 9%. So they almost go up to 50%, we used 43% in that other example. So you can see how, in that other example, we only qualified for a $1,500 per month house. But if we used a conventional loan, we could go up higher. We could probably go up to maybe a $1,700 or a $1,800 per month housing payment. That's going to drastically change how much you can qualify for.

FHA Loans

They will allow you to go even higher. They allowed you to go up to 56% so we could see in that example, You might be looking at anything from a $150,000 house, but if you use an FHA loan, you might be able to go up to a $225,000 house. Since your debt to income ratio is allowed to be higher, you can qualify for more of a mortgage.

USDA Loans

Actually drops it down a little bit. Normally it's around 41%. Sometimes you can get higher on USDA loans. But they can be a little tricky. They have somewhat of a tight box to qualify for.

VA Loans

If you're doing a manual underwrite, then you're wanting to stick around the 41% debt-to-income ratio. But VA actually really doesn't have a debt-to-income ratio that they follow. VA's kind of different in that they don't really follow the debt-to-income ratio rules. They use what's called a residual income.

But with VA, what you're mainly concerned about is do you have a good amount of money left? After you make payments, not necessarily what the ratios are.

Mid-600 and above credit score

Something to note as well is that if you have a low credit score, then you might not be able to qualify for the max debt-to-income ratio on these. These are normal if you have a mid 600 and above to get qualified on some of these scores. So keep that in mind.

Aim a low DTI percentage

But a debt-to-income ratio really isn't something that's super complicated. All you're doing is taking your total monthly debts. That includes your future housing payment divided by your gross income. And you want it to stick below these numbers. It can be anywhere on the very low end, but you cannot go past these numbers, right? You can't qualify for a loan. If you have a 70% debt-to-income ratio, that just means you have too much debt for the income that you have.

So hopefully that helps you understand what this looks like. Again, this is not going to tell you what you can afford. This is this isn't going to tell you what you should do. This is going to tell you what you could afford. So keep that in mind.

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