Debt to Income Ratio (DTI)

Debt to Income Ratio | Formula | Example | Mortgage Calculation

Debt to Income Ratio (DTI)

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Debt to income ratio DTI is the personal finance measurement. When we compare monthly payment to monthly revenue then this ratio calculation shows that what percentage of income debt payment makeup. In simple words, this ratio shows that what percentage of income is being paid out for monthly debt payment for credit cards, mortgages, and for the loan.

Debt to Income Ratio (DTI)

In the mortgage industry debt to income ratio is mostly used. Because mortgage broker confirms that you are able to manage your current debt or not. And you are able to pay your potential monthly mortgage payment before the issuance of the loan or not. They use this ratio to find out that you are able to cover your new mortgage payment and the current payment or not. For this mortgage broker check the current income and current monthly debt payment of yours.

For the qualification for the personal loan, there are many factors such as credit score, employment status, and personal assets. But if you have a low income then these factors have no worth and these are helpless for you.

How to calculate debt to income ratio for a mortgage from the formula.

Formula

Debt to income formula can be calculated by dividing the total monthly debt payment by gross monthly income.

Debt to Income Ratio = Total monthly debt payment/Gross monthly income

From the above equation, you can easily find out how much money you pay out every month in debt payment. By leaving the mortgage payment from the numerator mortgage companies tends to modify the debt to income ratio equation.

Analysis

As compare to high debt to income ratio, low debt to income ratio is better. Because if the debt to income ratio is low then it means that the small amount of income used as monthly debt payment from net income. So with the low ratio, you will be able to handle other expenses easily.

Debt to income ratio change over time to the industry, geographical location, and prime interest rate. e.g If any want to purchase the home in southern California have more flexibility in DTI as compare to that which purchase in the rural area.

This is the risky measurement ratio which lender use to analyze that you can afford the mortgage or not. If the ratio is high then you will not be able to afford the monthly payment.

Example

Ali applied for the mortgage to buy the home. Monthly card bills of Ali is $1000 and car loan payment is $500. Monthly mortgage payment for Ali in the primary home is  $1500. Total debt payment obligation from this value is 3,000 dollars. Total income of Ali is $60,000 for 1 year so monthly income is $5,000, Now we calculate DTI ratio as

60%= 3000/5000

So the debt to income ratio for Ali is 60% which means that the ratio is very high and Ali is not able to get the second mortgage.

For decreasing this ratio if we assume to increase the salary of Ali up to $75,000 but still the DTI ratio high which is 24. Due to this Ali fails to get the second mortgage.

For more Financial Ratio Check: 

Debt to asset ratio

Debt to capital

Debt to Equity Ratio

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