Mortgage lenders analyze your current debt in comparison to your income. This is depicted as a ratio called your debt to income ratio, or DTI. Lenders use your debt-to-income ratio, along with other credit information, to evaluate whether you can afford to repay the money you borrow from them.

Calculating your debt-to-income ratio can be very useful for you as well. You can use your debt-to-income ratio to check on your overall financial health and figure out whether you will be comfortable taking on more debt. You can also use the ratio to guide future financial decisions that can help you strengthen your ability to purchase a home in the next few years.

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Calculate debt-to-income ratio 

To calculate your debt-to-income ratio, use this simple formula:

DTI RATIO = MONTHLY DEBT / MONTHLY INCOME 

Take your monthly debt, which includes mortgage or rent, auto loan, credit cards, and any other monthly payments you make. Divide this by your gross monthly income, including paychecks and any other taxable income, before taxes and deductions. Your debt-to-income ratio is often expressed as a percentage. To get the percentage, simply multiply the number by 100.

What is a good debt-to-income ratio?

The lower your DTI is, the better. Lenders like to see a low DTI ratio because it typically means you will be able to pay back your loan more easily. Lenders and loan types have various DTI requirements, but generally, a debt-to-income ratio is required to be lower than 45%. Having a lower DTI can also help you increase your credit score. 

What is the average debt-to-income ratio? 

A debt-to-income ratio of 30-40% is standard. Lenders will work with borrowers who have a higher DTI; however, they’ll need to consider other factors, like whether you have additional assets or cash on hand. You can improve your DTI by paying off credit cards and other debts or by increasing your income. 

What is a high debt to income ratio?

A debt-to-income ratio of 50% or greater is considered high. This means at least half of what you earn in income, you pay towards debt. It doesn’t include what you pay out every month for insurance, utilities, or food. If your debt-to-income ratio is above 50%, this may indicate to lenders that you might not have the ability to repay a loan. If your DTI is high, you may want to hold off on taking on new debt and take some time to invest in your financial health and build a better financial safety net. 

How to lower your debt-to-income ratio

No matter what your debt-to-income ratio is, you can always take steps to improve it. Here are some ways you can lower your DTI, improve your financial health, and increase your ability to get a great home loan.

• Pay down your existing debt. If you’re saving to buy a home, you’ll want to consider whether you’d rather keep money set aside for a down payment, or use your extra cash to pay down other debts to get a better loan. If you can afford to pay down your credit cards, auto loan, student loans, etc., do it! This can significantly lower your debt-to-income ratio.
• Save up for major purchases. It can be tempting to take advantage of those offers to buy a new sofa with no interest for three years, or get a low rate if you buy a car now, but wait! Resist the urge to make big purchases on credit. Make homeownership a priority and do not open any new lines of credit. Lowering your DTI prior to or during the loan process could severely impact your ability to qualify. 
• Work on improving your overall financial health. Create a budget and stick to it. Monitor your debt-to-income ratio over time. Work to improve your credit score. Save up for a down payment on a home. Lenders look at the whole picture, so every bit helps!

Why Neat?

When you’re shopping for mortgages, it is important to partner with a lender who is dedicated to getting you a mortgage that fits your needs. At Neat Loans, we’ve cleaned up the home financing process so you can get your mortgage without the mess. Get pre-approved in 3 minutes with Neat.

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THANKS FOR READING! PLEASE NOTE THAT THIS CONTENT IS INTENDED FOR EDUCATIONAL PURPOSES ONLY. AS LAWS AND LENDER REQUIREMENTS CHANGE REGULARLY, YOU SHOULD SPEAK TO A HOME LOAN ADVISOR ABOUT YOUR PARTICULAR SITUATION. IF YOU’RE INTERESTED IN PURCHASING OR REFINANCING A HOME,  CHECK OUT TODAY'S MORTGAGE RATES OR GET PRE-APPROVED IN THREE MINUTES.