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Understanding the Impact of Your Debt-to-Income Ratio

A ceramic vase on a shelf that says HOME on it

While mortgage rates and closing costs might be the biggest numbers on your mind when you are considering buying a home in North Carolina, there is one number you can’t forget—your debt-to-income ratio, or DTI. In this week’s Home Matters Blog, we explore your DTI FAQs so you can better understand this important number and how it will impact your financial future.

What is DTI?
According to Investopedia, a debt-to-income ratio is the “percentage of your gross monthly income that goes into paying your monthly debt payments and is used by lenders to determine your borrowing risk.” Put in layman’s terms, your DTI ratio is a way of expressing how much you pay per month in debt in relation to how much money you bring in each month. A high DTI means that you have a lot of debt to pay off each month in relation to your income, so you might not be ready to take on debt. On the other hand, a low DTI tells lenders that you have a manageable amount of debt and will likely be able to handle paying off more in the form of a mortgage.

How is it Calculated?
Your lender calculates your DTI with a simple fraction: your DTI is the total of your monthly debt payments divided by your gross monthly income, or your income before taxes and deductions. You can find your gross income on your paystub. For example, if you pay $500 in debt payments each month and make $2,000 each month in gross income, your debt to income ratio would be 1:4, or 25%. That means 25% of your income each month goes toward paying off your debts. These debts can include credit cards, student loans, car loans and others added together.

Why is it Important?
The amount of debt you have to pay each month has a significant impact on the amount of your income that you can use for other things. For example, if you are paying $500 each month on your debt and make $2,000 per month, that leaves $1,500 for the rest of your bills. This number is important to a lender, because when they provide you a mortgage they want to be sure you can afford to pay it back. A DTI of less than 43% is the usual rule of thumb for lenders. That means they want you to be spending less than 43% of your income each month on debt repayment. While this may be the minimum, having a lower DTI will help you secure better mortgage terms.

How Can I Improve My DTI?
Since the two parts of your DTI are your income and your debt payments, it makes sense that the best ways to improve it are through increasing your income or reducing your debt. Before you start looking for a mortgage, work on paying down your debt so that you pay less each month on debt payments. In addition, any increases in income can help get your DTI where you want it to be.

Your DTI is an important number, but it is far from the only thing that your lender will consider when deciding whether to lend to you. Learn more by talking with a participating lender near you today.

For more information on buying a home, financing and home ownership, visit HousingBuildsNC.com.