Do you know how to calculate debt to income ratio? It is as simple as A ÷ B = C. When it comes to qualifying for a mortgage loan to purchase a home, lenders consider debt to income (DTI). Lenders know how to figure debt to income ratio and so should you. So let’s dive right into how to calculate debt to income ratio.
Your Debt to Income Ratio and How Lenders See It
Before learning how to calculate debt to income ratio, you need to know why it is important. Your debt to income ratio is a leading indicator as to whether or not you are a qualified borrower. Lenders use DTI to determine if you are a trustworthy and reliable borrower.
Generally speaking, borrowers with a higher DTI may have more trouble making payments because most of their financial resources are spent on the everyday essentials, such as bills. Borrowers with a lower DTI typically have more money left over after paying bills and therefore can take on the additional debt of a home loan more comfortably.
How to Figure Debt to Income Ratio That is Attractive to Mortgage Lenders
When applying for a conventional home loan, your DTI should be 50 percent or below to increase the chance of approval. For an FHA home loan, which is backed by the Federal Housing Administration, the requirements are more lenient. However, aiming for a DTI of less than 50 percent will make the qualifying process more streamlined. In all cases, approval is more likely for mortgage borrowers with a DTI of 43 percent or less. So, how do you calculate debt to income ratio to see if you are within this ideal range?
How to Calculate Debt to Income Ratio
Knowing how to figure out debt to income ratio is actually quite simple. You can get your answer in two steps:
Add Up Your Monthly Bills
First things first, add up monthly payments that are calculated into your DTI. These include,
- Rent or monthly mortgage payment
- Home owners insurance premium
- Home owners association fees that are paid monthly
- Auto loan payments
- Student loan payments
- Credit card payments
Monthly payments that are not calculated into your DTI include,
- Utility costs
- Health insurance premiums
- Food and clothing costs
- Personal loan payments
Divide the Total by Your Gross Monthly Income
Next, take the total amount calculated and divide it by your gross monthly income (income before taxes). For example, a borrower with rent of $1,800, a car payment of $500, a minimum credit card payment of $100 and a gross monthly income of $5,000 has a debt to income ratio of 48 percent. In most cases, a debt to income ratio of 20 percent or less is considered low and a debt to income ratio of 50 percent or more is an indicator of financial stress.
How to Improve Your Debt to Income Ratio
Knowing how to calculate debt to income ratio is one thing, knowing how to improve it is another. Improving your DTI can make a big difference in the type of financing you can obtain with a home purchase. There are several things you can do to improve your DTI depending on your urgency to do so.
- Negotiate your salary or create a second revenue stream. This is the most direct way to improve your DTI.
- Pay down your debt. Making extra payments can help decrease your overall debt more quickly.
- Transfer your debt to a zero-interest credit card. Utilizing offers with a 0 percent APR promotional period can help you pay down the principal of your debt, which will allow you to pay down the balance much faster.
- Consolidate your debt. Utilizing a consolidation loan can be a great way to improve your DTI. A consolidation loan combines your high-interest debts into one low-interest monthly payment. The amount of money you save will help pay down debt and improve your DTI.
Congratulations! Now you know how to calculate debt to income ratio. Today is a great day to pay down debts and set yourself up for home buying success.