Debt-to-income Ratio

Definition of "Debt-to-income ratio"

Rosanta  Vallone real estate agent
Rosanta Vallone, Real Estate Agent Fletcher Realty Services Inc

The Debt-to-Income Ratio (DTI) is one of the ways to assert ability to pay; that is, a way Lenders have to calculate if they will lend money to someone. The Debt-to-Income ratio (DTI) is all about figuring out if the borrower will be able to pay back the loan instead of constant defaulting because he/she is so stuffed with bills to pay and not enough money (income) to back them up.

Debt-to-income calculator

First thing you need to do to understand the Debt-to-income calculator is that the debt-to-income is calculated in the monthly sphere.

The debt = all monthly expenses related to loans. So, say you have a car lease where you pay $500 a month, a mortgage of $1,250 and another $250 for the rest of your debts: your monthly debt is $2,000 (500 + 1,250 + 250). Now, the income = your gross income. Let’s say your gross income equals $7000; all you have to do is get the 2,000 and figure out what percentage of 7,000 it represents (the answer is 28% for the people bad at math).

In our example, for you to understand clearly, we have put only loan-kind of debt, but you should also put anything that is a monthly expense, like alimony/child support, the minimum payment of your credit cards, monthly rent (if you do not own the house), student loans and whatever else is a monthly expense AFTER you arrive at your debt-to-income. Calculate the debt-to-income to know if lenders will borrow you, but then insert all those expenses for you to know the amount you will truly be spending per month.

What’s a good debt-to-income ratio?

If the debt-to-income ratio is assigned to decide if a lender will give money to a borrower, there has to be a bad and a good debt-to-income ratio number, right?

The outcome is the risk your loan provides the Lender, so, usually, the lowest, the better. And the magic number is 43%; you want it to be under that.

Aside from that, most lenders use the ratio 28/36, in which the first number, which is also referred to as the front-end ratio, is the percentage of your gross monthly income that you could comfortably afford to spend on your housing payments or mortgage. This figure includes the money you spend on property taxes and insurance as well as the loan payment itself. The second number, which can also be referred to as the back-end ratio, is the percentage of your gross monthly income that should be spent on all long-term monthly debts combined.

Use the following guidelines to find out where you stand:

  • First, figure out your gross monthly income (your income before taxes). To do this, take your gross yearly income and divide it by 12.
  • Multiply this figure by 28 percent (.28). The amount you come up with is TYPICALLY the amount you could comfortably afford to spend on your housing payments per month.
  • Now, take your gross monthly income (your gross yearly income divided by 12) and multiply it by 36 percent (.36). The figure shown should be the TOTAL amount of money you spend on ALL LONG-TERM DEBTS COMBINED.

Real Estate Tips:

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