Let us consider an example of a borrower looking to purchase a house. To calculate his/her debt-to-income ratio income let us assume the monthly debt payments include the following:
Monthly Mortgage Payment: $1200
Monthly Auto Payment: $500
Credit Car payment (minimum): $300
Total Monthly Debt Payment = $(1500+500+500) = $2000
Suppose the monthly incomes are as below:
Borrowerâ€™s Monthly Salary: $3500
Spouseâ€™s Monthly Salary: $2500
Other Income: $500
Total Monthly Income= $(6000+2500+500) = $6500
Debt-to-Income Ratio = Total Monthly Debt Payment/Total Monthly Income = (2500/6500) = 30.76%
A lower DTI ratio is considered better as less debt means the borrower is financially more sound and has a better opportunity to get a better mortgage loan. Therefore a lower debt-to-income ratio indicates that the borrower has a higher chance of repaying the debt compared to a borrower who has a higher debt-to-loan ratio and may have more trouble finding affordable mortgages.
In mortgage loans, lenders typically consider two kinds of debt-to-income ratios. First is the front ratio, which includes all the housing costs such as the mortgage principal, interest, mortgage insurance premiums, and property taxes. The second is the back ratio, which includes non-mortgage debt such as credit card payments, auto loan payments, child support payments, and student loan payments. Generally, lenders prefer less than 28 percent for a front ratio and 36 percent for a back ratio.
Lenders require different mortgage debt-to-income ratio depending on the mortgage type. For conventional mortgage loans, DTI ratios are typically 28/36 and a FHA mortgage loan has a DTI limit of 31/43. Debt-to-income is an important way to monitor ones expenses and buying power and help people in taking control of their expenses as well as keep track of them.