DTI – Debt To Income Ratio Acronym Description
DTI is consumer lending acronym that stands for, Debt To Income Ratio – used by banks and lenders as another benchmark for deciding on whether an applicant will qualify for a loan or not. It can also be used by the applicant to help them manage their finance plans and avoid getting into a situation where they cannot manage their cash flow and afford all of the other monthly expenses that they may have.
If the applicant’s debt to income ratio is too high, then the lender will decline the applicant. DTI is based on monthly income vs monthly finance expenses, property taxes, and explained further below.
To calculate DTI the lender adds up all of the applicant’s monthly loan and property tax expenses and divides that by the applicant’s monthly income. Example;
If an applicant’s total monthly expenses is $3000 for all of their loans etc and the applicant’s total monthly income is $5000, their DTI would be expressed in this equation;
$3000 ÷ $5000 = .60
Please note that banks will refer to your monthly expenses as your monthly debt obligations, or recurring debt. Don’t be confused – what they are is calculating your TOTAL monthly monetary obligations. They use your loan payments costs and divide that by your income to get your basic DTI, but they are also going to consider all of your monthly costs, such as rent, food, transportation, and any other costs.
Many banks will be more concerned with your DTI score than your actual FICO score, which makes good sense in some applicant studies. You can use this page for a DTI calculator if you wish over at Bankrate.
Each lender will have their own criteria for what is included in the calculation and also what the ratio or DTI level will be that they accept. Lenders have your best interests at heart as well as their own and these ratios are based on their experience with many borrowers and how often they get into trouble with their monthly payments.
For example, many clients will have a mortgage to pay each month and property taxes associated with the home. In addition they may also have a car loan, perhaps a personal loan for renovations they may have contemplated and most people have credit cards that they use on a regular basis. If the total of all of these payments is over 35% or 40%, then most lenders will recommend to their clients to not proceed with the loan application. These numbers are lower than the above numbers of 60%, since they do not include the cost of utilities and food expenses etc.
All of these numbers are measures and indicators and are meant as guidelines to help to assess the ability of clients to meet all of their obligations in terms of monthly commitments and still have sufficient money left over to pay for living expenses such as food, utilities, clothing and personal expenses that we all have.
For example, let’s assume that a client has a $100,000 mortgage for 25 years at 5%, a car loan of $20,000 at 5% for 5 years, a small personal loan of $5000 for 5 years at 5% and a credit card payment based on an unpaid balance of $5000 at 18%. The total monthly payments will be $3071 and then you add property taxes which we have assumed to be $250 a month for a total of $3614 a month in payment obligations.
Using the 35% ratio, this would mean that the client needs to earn a monthly income of at least $3600 or $43,000 a year in order to qualify for a mortgage or loan and they are already at the top of their borrowing limit. In fact if they only made this amount they would not qualify for any additional debt until they managed to repay some of this debt and clear it off the books. Consolidating some of the debt would help to reduce the monthly payments and improve their DTI or debt to income ratio, but they still are awfully close to the upper limit of 35%.
If you are applying for a loan or mortgage, find out in advance if you can, what DTI number the lender is using and what is included in the calculations to avoid any surprises. Clients can work out these ratios on their own to help decide the amount of debt that they may want to apply for and to avoid any disappointments when they are applying for a new mortgage or some other type of loan.