What is DTI in real estate? How to calculate it?

Your debt-to-income ratio (DTI) is a crucial factor that mortgage lenders use to evaluate your financial health. But, what is DTI in real estate? Simply put, the DTI ratio measures how much debt you have as compared to your income. Therefore, it plays a significant role in your loan approval. 

Knowing what is DTI in real estate is essential when considering buying a home. If you have a high amount of debt relative to your income, it’s wise to lower your debt before applying for a loan. Even if you feel ready to apply, finding a lender willing to work with a high DTI might be challenging.

Here, we’ll dive into what DTI is, how it works, and how it impacts your mortgage application so you can be well-prepared when you start shopping for homes.

So, what is DTI in real estate?

A DTI ratio is a simple way to see how much of your money goes towards paying off debt each month. You figure it out by dividing your monthly debt payments by your gross monthly income, and then you get a percentage. Loan lenders look at this percentage to see if you can handle more debt. 

Remember that if your DTI is high, lenders might think you’re a riskier borrower because most of your money is already tied up in existing debts. This could make it hard for you to pay back a new loan, especially if something unexpected affects your income.

When it comes to home mortgages, there are two parts to the DTI ratio that lenders look into.

• Front-end ratio: This is the percentage of your income that goes towards housing costs. It includes your mortgage loan payment, property taxes, insurance, monthly rent, and HOA fees.
• Back-end ratio: This includes all your monthly debt payments, such as credit cards, auto loans, child support, and student loans, plus your housing costs.

This way, loan lenders can get a full picture of your financial situation before deciding to lend you more money.

How is DTI calculated?

To calculate your debt to income ratio, you just need to do a bit of simple math. Add up all your monthly debt payments, then divide that number by your monthly income.

So, the formula is: DTI = Monthly debts / Monthly income

Here’s a step-by-step method to calculate your DTI:

1. Total up your regular monthly payments for things such as credit cards, student loans, personal loans, alimony, or child support – basically anything that shows up on a credit report. If you’re applying for a mortgage, include the proposed monthly mortgage payment in this total. If you’re applying with a spouse or co-borrower, include both of your debt payments.
2. Divide that total by your gross monthly income (that’s your paycheck before taxes, retirement savings, and other deductions, plus any other regular income you receive).

And, your DTI ratio is ready. Keep in mind that other monthly bills such as utilities, groceries, homeowners insurance, healthcare, and daycare aren’t included in your DTI calculation. Lenders won’t consider these when deciding how much to lend you. 

Also, remember that just because you qualify for a $300,000 mortgage doesn’t mean you should take a big loan. You should be able to comfortably afford the monthly payments when you factor in your whole budget.

What should be the ideal DTI in real estate?

Lenders usually prefer a DTI ratio of 43% or less before approving a loan. Most of them believe that the ideal DTI ratio should be 28% or less for housing costs alone and 36% or less for all monthly debts combined. However, depending on your credit score, savings, assets, and down payment, they might accept higher DTI ratios.

For conventional loans from Fannie Mae and Freddie Mac, lenders might go up to 50%, meaning half of your monthly income could go toward housing expenses and other debts.

Here’s a quick look at how different ranges affect your mortgage chances:

• Below 36%: You have manageable debt. Qualifying for a loan should be easy.
• 36% to 41%: You can handle debt and a new mortgage payment. Approval is likely.
• 43% to 50%: You have a lot of debt and may struggle to repay a mortgage.
• Over 50%: You’re likely not ready for a mortgage, and lenders will typically deny your application.

What are the best tips to lower your DTI ratio?

To get your DTI ratio under control, try these tips.

• Track your total spending. Start by making a budget to see where your money goes and cut out unnecessary purchases. This way, you can put more money toward paying off your debt. Include all expenses, big or small, so you can allocate extra dollars to debt repayment.
• Pay down your debts strategically. Use methods such as the snowball or avalanche approach. The snowball method focuses on paying off your smallest debt first, then moving to the next smallest. The avalanche method, on the other hand, targets debts with the highest interest rates first, saving you more on interest in the long run.
• If you have high-interest credit cards, see if you can lower your rates. Call your credit card company to ask for a lower rate or consolidate your debt by transferring high-interest balances to a lower-rate card. You could also take out a personal loan to combine high-interest debt into one loan with a lower interest rate.
• Avoid taking on more debt. Don’t make large purchases on credit cards or take out new loans, especially before or during a home purchase. Adding new debt will increase your DTI ratio and can hurt your credit score.

Key takeaway

The DTI ratio is a percentage that compares your monthly debt payments to your gross monthly income. It helps lenders assess your ability to manage monthly obligations and take on additional debt. And, for you, knowing your DTI helps you decide if now is the right time to buy a home or not. If it’s high, consider waiting. If it’s low, you’re in a good position to apply for a loan. To calculate your DTI ratio, the formula is monthly debts / monthly income. 

FAQs

Does my debt-to-income ratio impact my credit score?

Yes, there is a direct correlation. For instance, lowering your debt-to-income ratio can help boost your credit score by reducing your overall debt.

Why is the DTI ratio important in real estate? 

Lenders use your DTI ratio to determine your borrowing risk. A lower DTI ratio indicates that you have a good balance between debt and income, making you a less risky borrower.

Can a high DTI ratio affect my mortgage approval?

Yes, a high DTI ratio can make it harder to get approved or qualified for a mortgage, as it suggests you might struggle to manage additional debt payments.

What expenses are included in the DTI ratio?

The DTI ratio includes all monthly debt payments such as mortgage loans, credit cards, car loans, student loans, and alimony. It does not include expenses such as utilities, groceries, or insurance.

Can improving my DTI ratio help my credit score?

Yes, reducing your debt levels can lower your DTI ratio and improve your credit score by showing that you’re managing your debt responsibly.

Do all lenders have the same DTI ratio requirements?

No, DTI ratio requirements can vary by lender and loan type. Some lenders may be more flexible, especially if you have a strong credit score, significant savings, or a large down payment.

How can I improve my DTI ratio?

You can improve your DTI ratio by paying down existing debts, avoiding taking on new debts, and increasing your income.

Is the DTI ratio the only factor lenders consider for loan approval?

No, lenders also consider your credit score, employment history, savings, and the size of your down payment when evaluating your mortgage application.

Written by Ramona Sinha. November 28, 2024

Ramona is the Senior Content Writer for Kukun. This experienced blogger uses simple and succinct words to decipher the complex phenomenon called life. She has written articles covering a broad range of topics, such as real estate, lending and mortgage, finance, business, taxation, home designs, home improvement projects, decor concepts, and more. An avid traveler, she’s a digital nomad at heart and an animal lover from the depth of her soul.