Debt-to-income Ratio

Definition of "Debt-to-income ratio"

Written by

Rosanta Vallone

Fletcher Realty Services Inc

The Debt-to-Income Ratio’s (DTI) definition is a measure that allows one to compare the ability an individual has to afford a monthly debt payment out of their monthly gross income. The so-called ability to pay results from this calculation and that lenders consider this ability to pay when lending money to individuals.  The Debt-to-Income ratio (DTI) is all about figuring out if the borrower will be able to pay back the loan instead of constantly defaulting because they are struggling with bills to pay and not enough money (income) to back them up.

Debt-to-income calculator

The first thing you need to understand is that the Debt-to-income calculator 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 take the 2,000 and figure out what percentage of 7,000 it represents (the answer is 28% for the people bad at math).

DTI = Total monthly debt/gross monthly income

In our example, for you to understand clearly, we have put only loan-kind of debt. Still, you should also put anything that is considered a monthly expense after you arrive at your debt-to-income: 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. Calculate the debt-to-income to know if lenders will approve you, but then insert all those expenses for you to see the amount you will genuinely be spending per month.

What’s a good debt-to-income ratio in real estate?

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. In the first number, we can also include any money spent on property taxes and even insurance. 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.

Through the steps below, you can figure out what your is:

• Step one: take your gross annual income and divide it by 12 - this is your gross monthly income before taxes.
• Step two: multiply this figure by 28 percent (0.28) - this is the amount of money you could reasonably afford for your monthly housing payments.
• Step three: take your gross monthly income and multiply it by 36 percent (0.36) - this is the amount of money you could reasonably spend for the total of all long-term debts.

Real Estate Tips:

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