Everyone knows credit score is important when applying for a loan, but lenders also consider your debt to income ratio to determine how much you can borrow and at what interest rate.
So what does debt to income ratio, or DTI, mean? DTI is a measure that compares your monthly debt payments to your monthly gross income. (Remember, gross income is your income BEFORE taxes and other deductions are taken out). This measure helps lenders determine your borrowing risk. A low DTI indicates sufficient income relative to debt servicing, and it makes a borrower more attractive. So, you want a high credit score, but a low DTI.
How do you calculate your DTI?
Your monthly obligations such as credit card payments, loan payments, child support and rent or mortgage payments are used to determine your DTI. To figure out your DTI, simply add up all of your regular monthly housing and debt payments, and divide that number by your total gross monthly income. The result will yield a decimal, so multiply the result by 100 to achieve your DTI ratio.
Total of Monthly Debt Payments
Gross Monthly Income
Expenses like groceries, utilities, gas and your taxes are generally not included in this calculation. So, let's say all of your monthly bills add up to $2,000 per month and your gross monthly income is $6,000. Then your debt to income ratio is 33%. This falls into the range that most lenders will approve. It's a good rule of thumb to keep your DTI at 40% or below.