Debt to Income (DTI) ratio basics

The Debt to Income (DTI) ratio is a critical factor in the mortgage lending process as it helps lenders determine the borrower's ability to repay the mortgage loan. It compares the borrower's monthly debt payments to their gross monthly income.

To calculate the DTI ratio, the borrower's total monthly debt payments (including housing expenses, credit card payments, car loans, student loans, and any other outstanding debts) are divided by their gross monthly income before taxes and other deductions.

For example, if a borrower has a monthly gross income of $5,000 and $2,000 in monthly debt payments, their DTI ratio would be 40% (2,000/5,000).

Lenders typically prefer borrowers to have a DTI ratio of 43% or lower. However, some lenders may offer loans to borrowers with higher DTI ratios if they have a strong credit score, substantial cash reserves, or other compensating factors.

In addition to the front-end DTI ratio, which includes only housing expenses, there is also a back-end DTI ratio that includes all debt payments. Lenders may use either ratio or both to evaluate a borrower's ability to repay the mortgage loan.

A lower DTI ratio is generally considered better, as it indicates that the borrower has more disposable income and can comfortably make their mortgage payments. It also reduces the risk of default and foreclosure for the lender.

Borrowers can improve their DTI ratio by paying off outstanding debts, reducing their monthly expenses, or increasing their income.