The Importance of Debt-to-Income Ratios

Two businesspeople discussing details of a contract

Sometimes it feels like home buying has its own language. There are several new terms you’ll encounter throughout the buying process that can get confusing quickly.

If you’re applying for a mortgage or other financing, there’s a chance you’ve seen a few new terms that may make you scratch your head. One of them, the debt-to-income ratio, is an important term to know before you even start looking at homes!

What is my debt-to-income ratio?

The debt-to-income (DTI) ratio is one of the most important factors lenders use to determine your creditworthiness. In short, it compares how you much you owe each month to your monthly income.

How to calculate your debt-to-income ratio

Calculating your debt-to-income ratio is simple and something you can do on your own. Simply add up all of your monthly obligations (i.e. monthly credit card payments, car payments, student or other personal loan payments, and other financial obligations) then divide that number by your gross monthly income (before taxes and deductions). The number you have left is your debt-to-income ratio.

Why the debt-to-income ratio is important

The debt-to-income ratio has a significant impact on your ability to get credit. How? Lenders want to make sure you’ll be able to repay your loan so they scrutinize how much debt load you’re currently carrying. If your debt-to-income ratio is low (typically lenders look for a ratio of 36% or lower, though you might still be approved with a higher DTI. That decision is entirely up to your lender), you’re more likely to be able to repay your loan. However, if your ratio is high, that stands as a warning that you may not be able to repay new debt, including the mortgage.

My DTI is high. How can I improve it?

If your debt-to-income ratio is on the high side, don’t worry; you can fix that. You can improve your ratio by either increasing your income or lowering your monthly debt obligations. If you’re early in the homebuying process, it’s a great time to focus on paying down those outstanding loans to improve your financial standing and refrain from opening new lines of credit.

Being aware of your financial health is important to avoid any unwanted surprises during the mortgage application process and improve your chances of getting the home of your dreams.