DEFINITION OF ‘DEBT-TO-INCOME RATIO – DTI’
A personal finance measure that compares an individual’s debt payment to his or her overall income. A debt-to-income ratio (DTI) is one way lenders (specifically mortgage lenders) measure an individual’s ability to manage monthly payments and repay debts. DTI is calculated by dividing total recurring monthly debt by gross monthly income, and it is expressed as a percentage. For example, John pays $1,000 each month for his mortgage, $500 for his car loan and $500 for the rest of his debt each month, so his total recurring monthly debt equals $2,000 ($1,000 + $500 + $500). If John’s gross monthly income is $6,000, his DTI would be $2,000 ÷ $6,000 = 0.33, or 33%.
EXPLANATION OF ‘DEBT-TO-INCOME RATIO – DTI’
A low debt-to-income ratio demonstrates a good balance between debt and income. Conversely, a high DTI can signal that an individual has too much debt for the amount of income he or she has. According to studies of mortgage loans, borrowers who have lower DTIs are more likely to successfully manage monthly debt payments, so lenders prefer to see low numbers. In general, 43% is the highest DTI a borrower can have and still get qualified for a mortgage. A debt-to-income ratio smaller than 36%, however, is preferable, with no more than 28% of that debt going towards servicing a mortgage. While the maximum DTI will vary by lender, the lower the number, the better the chances that an individual will be able to get the loan or line of credit he or she wants.
There are two ways to lower DTI: reduce monthly recurring debt and/or increase gross monthly income. Using the above example, if John has the same recurring monthly debt of $2,000 but his gross monthly income increases to $8,000, his DTI would be $2,000 ÷ $8,000 = 0.25, or 25%. Similarly, if John’s income stays the same ($6,000) but he is able to pay off his car loan and reduce his monthly recurring debt payments to $1,500, his DTI would be $1,500 ÷ $6,000 = 0.25, or 25%. If John is able to both reduce his monthly debt payments to $1,500 and increase his gross monthly income to $8,000, his DTI would be $1,500 ÷ $8,000 = 0.1875, or 18.75%.
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DTI is the Debt to Income Ratio.