Debt to Income is a term you’re going to hear nearly every time you apply for a loan, though it’s seldom explained. Let’s take a minute to review what it is, what it isn’t and how it impacts you.
Debt to income, or DTI, is a ratio used to determine how much house you can afford. Here’s how it works:
Take your annual salary and divide it by 12. This is your gross monthly income. Multiply this amount by .36 (36%). This is the recommended maximum DTI ratio for the average borrower. To figure out how much house you can buy, subtract your current monthly payments that report to credit from this dollar amount. For example, if you make $60,000 a year, here’s the math:
$60000 / 12 = $5000 (so $5000 is your gross monthly income)
$5000 x .36 = $1800
Now, let’s say you have a student loan, a credit card and a car payment; subtract these:
Gross Income $1800
Car Payment -$350
Student Loan Payment -$100
Credit Card Payment -$50
This is the house payment you can afford. In this example, $1300.
Nearly everyone has debt but not everyone defines it the same. Here’s what it means to a lender: financial obligations that report to credit. Let’s break it down.
What else could count?
Court-ordered obligations like child support, separation maintenance and alimony are counted as debt when applying for a mortgage.
What doesn’t count?
Unless you are applying for a VA (veteran) loan, other monthly payments do not count towards your DTI. Things like utilities, child care, insurance and phone bills are not calculated. This is why a 36% DTI is considered a healthy ratio, to account for these expenses and other costs of living like entertainment.
Let’s go back to the above example, on paper, $1300 looks like a lot of money to buy a house with. Before you get too excited, there are three other factors to consider:
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