How To Lower DTI

What is the debt-to-income ratio?

The debt-to-income (DTI) ratio for buying a house is a comparison between income and monthly debt payments. Debt-to-income ratio is the sum of all monthly debt payments divided by gross monthly income. According to the Consumer Financial Protection Bureau, this number is one way lenders measure the ability to manage the monthly payments to repay the money borrowers plan to borrow.

 Several factors determine how much house a borrower can afford to purchase. These factors include credit score, income, debt-to-income ratio, down payment amount, and more.

Types of debt-to-income ratios

There are two primary types of DTI: front-end DTI, and back-end DTI.

 Front-end DTI. This ratio takes into consideration all the expenses that are related to a house or property, including rent or mortgage payments, property taxes, homeowners' insurance monthly payments, and homeowners associate dues (if applicable).

 To calculate front-end DTI, add housing-related debt and divide this number by monthly income. For example, if the monthly gross income is $6,000, and someone pays $2,500 in monthly housing payments, there is a front-end DTI ratio of 41%.

Back-end DTI. This takes into consideration the amount of income used to pay all monthly debt including current rent or mortgage, plus credit cards, student loans, and a car loan.

For example, if a borrower has a monthly gross income of $6,000 and $3,000 in monthly liabilities (a $2,500 monthly mortgage/insurance payment and $500 in credit card payments), a back-end DTI ratio will be 50%. Many lenders will not consider a DTI this high, and of the ones that do, a higher interest rate is applicable.

Lenders consider both front-end and back-end DTI ratios to decide risk for borrowers. Different lenders have unique lending criteria, and each type of mortgage loan program has unique requirements as well.

Debts used to calculate debt-to-income ratio

When applying for a mortgage, the lender will ask to see proof of monthly debt payments and use these figures to calculate DTI for the mortgage.

The debts considered for DTI are:

• Credit cards. All outstanding balances will be added.

• Installment loans. This includes any debt that is being paid off in installments, such as an auto loan, medical bills, student loans, etc.

• Other mortgages. This monthly payment will count toward debt.

• Support payments. This includes spousal support and child support.

Debts excluded from the debt-to-income ratio

These kinds of debts and payments that are not added to the DTI for a mortgage:

• Food/entertainment

• Phone/cable bill

• Utility bills (water, gas, electric, etc.)

• Existing mortgage debt to be paid off within 10 months or less (at lender’s discretion)

How to calculate debt-to-income ratio

Add up monthly debt payments (excluding utility, phone, and food expenses).

Divide monthly payments by gross monthly income (the amount of money earned before taxes and other deductions are taken out).

Convert to a percentage by multiplying the decimal by 100.

How to lower your debt-to-income-ratio

If your DTI is too high, here are some strategies to help lower debt-to-income ratio:

• Pay off debt. Reducing debt will have a significant impact on your DTI. If a borrower is saving money to buy a home, before putting money aside start paying down and paying off credit card debts.

• Refinance existing loans. Refinancing to a lower interest rate often allows for a lower monthly payment amount.

• Research loan forgiveness. Loan forgiveness programs are often connected to student loans.

• Pay off high-interest loans. Whenever there is extra money available, pay off high-interest loans and debts first. A borrower can also reduce debt and save money on interest payments.

• Find a co-signer. Purchasing a home using a mortgage can be challenging on one income. Getting a co-signer (such as a spouse, partner, parent, or relative) on the mortgage loan can help you get approved. The lender will consider the income and debt of both people. A co-signer is equally as responsible for the mortgage payments and will have to pay the loan if the primary signer fails to pay.

• Increase income. Getting a second job to increase monthly income or asking for a pay increase can help pay off your debts and increase income ratio.

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