What is DTI?
DTI stands for debt-to-income and is a term used to describe the percentage of your monthly income before taxes that goes toward paying any debts. DTI is used in determining credit scores and lenders when deciding whether or not to loan money. Debts used to calculate debt to income ratio include car payments, child support, credit card payments, and student loans.
Lenders consider a good DTI to be 35% or less, 36% to 49% showing opportunity to improve (but the lender may still possibly issue a loan), and a DTI of 50% or more as an indication that an individual won’t have the funds to pay back debt, especially if an emergency were to further strain their finances. For conventional mortgages specifically, a DTI of 43% or less will work. Different loan programs have different DTI qualifications so if you are looking for a non-conventional loan, check with your lender for the DTI required.
A DTI score can be improved in several different ways:
- Pay down your current debt. Start with credit cards and student loans. If you are able to pay down the principal on a mortgage or car payment, this can also positively affect the DTI ratio (a lower DTI is better).
- Increase your income. Higher pay from a promotion or a new position will lower a DTI.
When anticipating applying for any kind of loan, calculating DTI and making any needed improvements before the application process starts will significantly improve the chances of success.
DTI case study
Let’s say Sangmin wants a loan for a small home renovation. His gross salary is $120,000 a year or $10K/month, whose debt payments (including mortgage, student loans, car payment, and an anticipated home rehab loan) add up to $4,800.
To calculate Sangmin’s DTI, you would divide $4,800 by $10,000, giving you a DTI of 48%. Most lenders would consider 48% risky, as Sangmin might not have the financial ability to pay back their loan if something unforeseen were to happen. Sangmin likely will not get the money he needs to fix his abode.
Let’s explore a different scenario. Sangmin knows that he’d like to do a renovation sometime in the next year. He runs the numbers from the above example and finds out his DTI is 48%. Knowing that this DTI may result in a polite decline from lenders, he springs into action with a different plan.
Over a few months he decides to cut back on eating out and pays down a credit card. He also realizes his performance review is coming up at work, and he makes a presentation for a promotion. His boss says yes, and now Sangmin’s gross salary is $130,000, or $10,833/month. His monthly debt payment is down to $4,500 a month.
Calculating his new DTI, $4,500 divided by $10,833, we find his new DTI is a significantly improved 41.5%. He’s still teetering right around the danger zone, but a few changes in his financials have now increased his chances of lenders approving his loans. If he is turned down, he can continue to use his increased salary to pay down other debts, lower the DTI further, and eventually be granted the loan.
The bottom line
DTI is short for debt-to-income, and refers to how much debt someone carries in relation to their income. This calculation impacts credit scores and lenders’ decisions when determining whether to loan money.