Debt to income ratio

The formula for figuring the debt-to-income ratio is simple, but lender definitions of ‘income’ and ‘debt’ are not.

The debt-to-income ratio, or DTI, is the key measure lenders use to determine whether or not you qualify. Because recent guidelines from the Consumer Financial Protection Bureau discourage lenders from providing mortgage financing to anyone with a DTI ratio greater than 43%, this has become the maximum DTI ratio allowed for most, but not all, loan programs.

This means that the total of your monthly debt cannot exceed 43% of your gross (pre-tax) income with most loan programs. I will give you a simple example for DTI, and then explain some of the complications that arise when you try to figure this ratio yourself.

EXAMPLE:
Our borrower has an annual salary of \$130,000, or \$10,833 per month. If we take 43% of that monthly income, we get \$4,658. That is the maximum amount of monthly debt that most lenders will allow her to have. If she has student loan payments of \$265 per month, an auto lease with a payment of \$414, and her minimum monthly payments on her credit cards total \$288, the non-housing portion of her monthly debt totals \$967. Subtracting that from \$4,658 leaves her \$3691 for housing expense before she exceeds the 43% limit. If she is looking at a new home that will have a monthly mortgage payment of \$2622, property taxes of \$630 per month, homeowner’s insurance of \$142 per month, and mortgage insurance (MI) of \$222 per month, her total housing expense will be \$3,616. Again, non-housing monthly \$967 + housing \$3,616 = \$4,583. Then, divide that total expense \$4,583 by her income of \$10,833 = 42.3%. Voila! She qualifies!

Now, for that devil who lives in the details:
Income, to a lender, can be simple – but it rarely is. For a salaried borrower whose income has been stable over the last couple of years, the calculation is easy – gross monthly income. Look at the year-to-date income line on a pay stub dated April 30 and divide by 4 = monthly income. However, if you receive a bonus, the lender will want to see a two-year history, and may want your employer to indicate that its continuance is likely, or it probably won’t be considered when the lender is qualifying you. Commission income also needs a history. If you are a salesperson who has just started hitting the ball out of the park, you may not qualify for as large a loan as you’d like – the lender will probably revert back to a two-year average when considering your commission income.

If you are self-employed you will need to have a lender look at your situation and tell you, from the lender perspective, what your DTI is. The lender will need two years of tax returns and a year-to-date profit and loss.

Debt also can be complicated. Some loan programs will allow you to pay off debt in order to lower your DTI so that you can qualify; other loan programs won’t. Your lender will have to guide you. If an auto loan has less than ten payments left, the debt won’t be counted against you. If you have deferred student loan payments, the lender will need to see the schedule of future payments. Also, student loans can sometimes appear multiple times on a credit report; if you have student loans, review the credit report and make sure they are reporting correctly. Be aware that your DTI will be figured on the minimum monthly payment that the creditor is reporting to the credit agencies. Check your credit report, and If that number has been reported incorrectly, let your lender know.

If you have any unusual debt or income circumstances or are cutting it close to 43% DTI, run your situation by a lender as soon as possible. If you have questions, feel free to call me.