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What is the debt-to-income ratio?

On Behalf of | Feb 6, 2020 | Firm News |

If you want to buy a new home, then you probably know that you need to make sure your finances are in order. You may save up money to make your down payment, knowing that if you save more, then you will save money on your loan. You may even pay down some debts. What you may not know is that you also need to keep an eye on your debt-to-income ratio.

The Consumer Financial Protection Bureau explains that the debt-to-income ratio is a very important percentage that your lender will look at to determine if you can afford to make your mortgage payments should the lender extend you a loan. The DTI is your monthly debts divided by your gross monthly income.

For example, if your debt payments each month equal $400 and your gross income, which is your income before taxes, equals $4000, then your DTI is 10%. This is a very low number for example purposes only. It is more common to see DTIs in the 30% range. The industry standard for getting a mortgage loan is 43% or lower. However, each lender has the right to reject a DTI it feels is too high, even if it is not over 43%.

Ideally, your lender will want to see a low debt-to-income ratio because this means that you have adequate income to pay your debts with plenty left over to pay your mortgage. It also shows that you will be able to manage unexpected expenses and that you likely have a good savings built up.

If your DTI gets too high, it is a warning sign. Your lender may see it as you being on the edge of financial trouble. If you owe too many debts and your income almost equals your debts, then all it will take is one issue that comes up to send you into financial chaos. Your lender sees this as too big of a risk.