Prospective borrowers who are looking into mortgages or other financing options have likely heard the phrase “debt-to-income (DTI) ratio” — which may cause them to ask, “what is DTI and why does it matter?”
Despite the name, debt-to-income (DTI) ratio is often expressed as a percentage and is one of the multiple factors that can determine the loan amount a lender chooses to extend to the borrower.
What Is Debt-to-Income Ratio?
DTI ratio indicates what portion or percentage of a borrower’s gross — or pre-taxed, monthly income goes towards monthly debt payments.
Those with a good DTI ratio will typically have less — or more manageable, debt. Lenders tend to prefer applicants with a good DTI ratio as they are seen as low-risk borrowers with the means to afford the loan.
Because DTI ratio can help borrowers in pursuing — and reaching, personal financial goals, couples and individuals can benefit from understanding all aspects of DTI ratio and how to manage it.
Types of DTI Ratios
When asked to supply their DTI for a loan application, the lender could be referring to either front-end DTI ratio or back-end DTI ratio.
Front-end ratio is also known as household ratio and represents the percentage of an individual’s or couple’s gross monthly income that goes into covering monthly, home-related expenses.
This can include costs such as property taxes, homeowner’s insurance, and mortgage payments.
A person’s back-end ratio is their collective monthly debt compared to the gross monthly income.
As the back-end ratio accounts for all debt, such as student loans, personal loans, credit card payments, in addition to household expenses, it is usually higher than the front-end ratio.
Lenders generally investigate both types of DTI ratios to determine loan amounts, although financial institutions extending conventional mortgages focus more on the applicant’s back-end ratio.
Those who are considering government-backed mortgages from federal agencies — such as the United States Department of Housing and Urban Development (HUD), have more flexibility because both DTI ratios are considered.
Even back-end ratios that are as high as 50% can be accepted by federally supported lenders.
It’s important that borrowers assess their financing options in order to find the best choice to suit their needs.
What Is a Good DTI Ratio?
For lenders, the DTI ratio of an applicant speaks to their ability to manage debt. As a result, loan officers are more likely to offer higher loan amounts and lower interest rates to those with a good DTI ratio.
This is particularly important for loans that help finance large-scale purchases, such as auto loans or mortgages.
What is considered an acceptable DTI ratio can depend on the lending institution and the type of loan the borrower is applying for. But in general, DTI ratios are categorized according to these percentages:
- DTI Ratio of 36% or Under: Most lenders consider this to be the ideal DTI ratio, especially as it’s common for borrowers to spend approximately between 28% and 36% of their monthly gross income on a monthly mortgage payment.
- DTI Ratio between 43% – 45%: While not ideal, if the DTI ratio falls anywhere between 43% and 45% it is still seen as acceptable by many lenders.
- DTI Ratio of 50%: This is generally the highest a DTI ratio can reach to remain qualifiable for most types of loans.
- DTI Ratio Over 50%: Prospective borrowers who have a DTI ratio that’s over 50% should focus on overcoming current levels of debt before trying to access new lines of credit.
Before looking into applying for a loan, it is typically in the borrower’s best interest to assess their financial situation and, if necessary, focus on managing their debt to improve the DTI ratio.
Calculating DTI Ratio
Prospective borrowers can determine their DTI ratio by taking the sum of their monthly debt payments and dividing it by their gross monthly income — or the amount earned before taxes and other deductions are applied.
And because DTI ratio is often expressed as a percentage, it’s recommended that borrowers convert the resulting figure into a percentage by multiplying it by 100.
Some financial institutions also offer an online debt-to-income calculator to help individuals, or couples determine their DTI ratio.
HRCCU members can access the necessary information to calculate their DTI ratio, monitor expenses, and savings either online or through the mobile banking app.
Manage or Lower DTI Ratio
The key to acquiring a good DTI ratio is savvy debt management. Many of the tactics used to manage or lower a DTI ratio are also applicable to reducing debt.
One significant hurdle to paying off debt is reducing the amount of interest associated with a bill or debt. The principal loan amount may take longer to pay off if most of the payments are going towards reducing the interest of the loan.
Borrowers should prioritize tackling high-interest debt before managing other debt.
Alternatively, borrowers can consider refinancing their loans or negotiating with the lending institution for more favorable loan terms — like a lower interest rate or reformed payment schedule.
Those who qualify may find it beneficial to enlist in a federal loan forgiveness program.
Depending on the loan type and program, borrowers can commit to volunteer projects or public service for a certain amount of time. In exchange, a portion or even all of their government-backed debt can be absolved.
Students, for instance, can join a volunteer program like AmeriCorps or enroll in the U.S. Army National Guard to help reduce their student debt.
Regardless of your situation, a quality financial institution ensures members are aware of their options.
HRCCU members have access to several affordable financial counseling services to help them manage debt, increase savings, and enhance their borrowing power.
Discover the Financing Opportunities at HRCCU
Whether you’re looking to increase your borrowing capacity or finance a milestone purchase like a first vehicle or home, HRCCU has the financing opportunities that can help achieve these goals.
Our programs are created to assist members in every aspect of their personal financial health. With help from the financial experts at HRCCU, members can become that much closer to achieving their financial goals.
To learn more about the financial services at HRCCU, contact us today.
