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The mortgage process

What is DTI, and why does it matter when applying for a mortgage loan?

By Julie Tramonte

August 2020

For many first-time homebuyers, navigating the mortgage process is almost like being in a foreign country and not speaking the language. One of those I-have-no-idea-of-what-you’re-talking-about terms? “DTI,” or debt-to-income ratio.

What comes in, shouldn’t necessarily go out

When underwriters are determining whether to approve your loan application, they look at your DTI. In simple terms, this is a mathematical equation that compares how much money you bring in against how much you pay out each month.

This percentage is derived from dividing your monthly debt payments by your gross monthly income. For example, let’s say you make $60,000 a year and your monthly debt is $2,000 each month. If you divide the $2,000 in debt payments by your gross monthly income ($5,000), your DTI is 40%.

Your debt-to-income ratio needs to fall under a certain threshold in order to be considered a good risk for a mortgage loan. While some loan programs allow for a higher DTI in certain circumstances, lenders are typically looking for a DTI of 43% or less.

What counts as debt?

Debt is basically everything you owe each month, such as your rent, car loan payment, student loan payment, alimony, child support or minimum credit card payment. Surprisingly, some of your other monthly expenses, like utilities, groceries and gas, aren’t considered part of that debt equation. That’s because while those may be predictable expenses each month, they’re more like regular cash purchases than debts you owe.

For a breakdown of how to calculate your own DTI, check out this explanation from my colleague Robin. 

If I pay all my bills, why does the ratio matter?

Underwriters are charged with determining the level of risk that you may not be able to pay the mortgage loan back. You could earn $10,000 each month but if your bills are almost as much, there isn’t much wiggle room for the “what-ifs.” Underwriters consider things like: If they take on another payment, will they be able to afford it? If an unexpected event happens, like a job loss or medical bills, will they be able to handle it financially?

In fact, your DTI will affect not just whether a lender will extend a loan to you, but how much of a loan. A lower DTI generally means you could afford to add a larger mortgage payment into the mix.

Here’s another reason why it matters: A low DTI is an indication of financial responsibility. It’s a good predictor of whether a borrower has the discipline to live within their means and not overextend themselves or max out their credit cards. 

How can I lower my DTI?

To lower your debt-to-income ratio, you can do one of two things:

  1. Reduce your debt by paying down (or off!) your loans or credit cards.
  2. Increase your gross monthly income by getting a pay increase or an additional job (without increasing your expenses).

Neither is fast nor easy. In fact, you may have to put your homebuying plans on hold until you can lower your DTI. But the silver lining is that you can rest easier knowing a lower DTI is a good indicator of your financial health!

Related to This

Tamara Rasmussen •

I appreciate the wealth of knowledge this being shared with me here, and I’ve learned so much about the home buying process that I didn’t know prior. Thank you so much.

Monica Tiffith •

Should I pay off my credit card and car loan first before buying a house?

Liz - Readynest Editor •

There's no right answer to that question, Monica! Paying off or paying down your debt will usually put you in a better position when applying for a mortgage, but will also delay your home purchase. It depends on your individual situation - your credit score, your DTI right now, the housing market in your area, and other factors.

Sandra Allen •

This was very clear to understand.

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Julie

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Julie Tramonte is a writer who joined MGIC in 2018. Prior to flying the coop, she wrote for a mattress company, a manufacturer and advertising agencies. She’s obsessed with reading, traveling, tennis and rearranging furniture. Mother of 2 beautiful, adult daughters. Empty nester who recently downsized. Her guilty pleasures are doughnuts and the Kardashians (don’t tell anyone).
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