Posted by Apex Home Loans ● June 25, 2014

Debt-to-Income Ratio, Explained

Grey House Model on Pile of Money. Learn about Debt to incomeAre you starting to look for a new home or for one that better fits your needs? You're in the right place: homebuyers are smart to shop for a loan first. It's easier to get sellers to take a buyer seriously and help move along the closing process when the buyer has already secured financing. If you're looking to get a mortgage, you've likely heard the term "Debt-to-Income" (DTI) ratio before. In this piece, we'll explain what DTI is and why this is the most important factor for mortgage application approval.

What Is a Debt-to-Income Ratio?

A debt-to-income ratio is simply the percentage of debt compared to the amount of income that a person brings in. For example, if you were to make $1,000 a month and have $500 worth of debt, then you would have a DTI of 50 percent. Experts recommend that potential borrowers keep their DTI under 43 percent to improve the odds of getting a home loan and ensure financial wellness.

What Debt Will Lenders Look At?

The good news is that lenders will disregard some debt when calculating a borrower's DTI. For example, a health insurance premium would not be factored as part of your DTI, and income is calculated on a pre-tax basis. This means that you don't have to factor in taxes when calculating qualifying income. What lenders will look at are any installment loan obligations such as auto loans, student loans, and any revolving debt payments, such as credit cards or home equity lines of credit. In some cases, a lender may disregard an installment loan debt if the loan is projected to be paid off in the next 10-12 months.

What Is Considered Income?

Almost any source of income that can be verified will be counted as income on a mortgage application. If you receive alimony, investment income or money from a pension or social security, then sources will be be included in qualifying monthly income when you apply for a loan. Wage income is also considered as part of a a homebuyer's monthly qualifying income. Self-employed individuals can also use their net profit as income when applying for a mortgage. However, many lenders will average income in the current year with income from previous years.

How Much Debt Is Too Much?

Many lenders will only offer loans to those who have a debt-to-income ratio of 43 percent. That doesn't mean you have no options if your DTI doesn't stack up, however. Government-backed loans may allow borrowers who have a DTI of 50-55 to qualify for a loan, depending on their income and other factors. Talk to a lender prior to starting the mortgage application process to learn if they have mortgage products that offer leeway.

Find Out More About DTI

Your Debt-to-Income ratio may be the biggest factor when a lender decides whether to approve your mortgage application. To amplify  your chances of loan approval, devise a plan to lower your DTI by contacting a Certified Mortgage Planning Specialist. 

Topics: Mortgage Financing, Mortgage Loan Information, Buying a Home, Debt To Income Ratio, DTI, Planning Your Mortgage