What is Debt-To-Income Ratio (DTI Ratio)?

For someone who doesn’t carry a lot of debt, I didn’t give Debt-to-Income Ratio a serious thought until I start lending money on peer-to-peer lending networks — i.e., Prosper and Lending Club. The truth is, DTI is important; especially in the business of borrowing and lending money.

Definition of Debt-To-Income Ratios (DTI)

Debt-to-income ratio, or DTI ratio, is the way a bank or lender determines what you can afford to borrow by determining your ability to pay back the loan. DTI ratio takes all of your monthly liabilities and divide the total by your gross monthly income. The result is a percentage called DTI ratio, and it must fall under a certain percentage for you to qualify for a loan. Generally,the maximum DTI varies by lender, loan program, and investor, but the generally accepted number is around 36%.

Two Kinds of Debt-To-Income Ratios (DTI)

Front Ratio

This is the percentage of gross income that goes toward housing costs. For homeowners this is PITI divided by income (PITI includes Mortgage Principal, Interest, Taxes, and Insurances). For renters, this is rent divided by income (i.e., rent-to-income ratio).

Back Ratio

This is the percentage of gross income that goes toward paying all recurring debt payments, including those included in the front ratio. Examples of other debt payments include payments for credit cards, car loan, student loan, child support, etc.

Three Reasons Why Debt-To-Income Ratios (DTI) Is Important

  1. Sub-prime Mortgage Meltdown – If some people in the real estate and mortgage industry didn’t get too greedy, we wouldn’t be having this problem that led to market decline, bankruptcies, unemployment, economic downturn, etc. Here’s a real life example. My wife and I were shopping for a bigger home in 2007. Our real estate agent showed us a million dollar home and suggested that we could afford a $3,900 monthly mortgage with our income. If we followed his “advice,” our mortgage would represent a front ratio of 49%. I am sure it wouldn’t take long for us to get into financial trouble and foreclose on the house.
  2. Credit Worthiness – One of the five C’s of credit is capacity, or the borrower’s ability to make their loan payment. This capacity is in direct correlation with DTI. In general, a borrower with higher DTI is more likely to be delinquent or default on his loan. When I lend money on Prosper and Lending Club, debt-to-income ratio (back ratio) is one of the first things I look at. In general, I try to avoid lending money to borrower with DTI greater than 36% — the suggested debt-to-income ratio that most lenders use.
  3. Financial Health – With widespread use of credit card and monthly payment plan, some people do not realize how deeply they are in debt. All they think about is, $10 more per month or $50 more per month, but little things do add up. Keeping track of your own DTI is a great way to keep yourself in check, and not fall into the pit of financial imprisonment. I think my friend Paidtwice said it best, “Less Debt = More Freedom

So that’s DTI in a nutshell. I hope you enjoyed the post.

More about Debt-To-Income Ratio:

About the Author

By , on Jan 29, 2008
Pinyo
Pinyo is the owner of Moolanomy Personal Finance. He is a licensed Realtor specializing in residential homes in the Northern Virginia area. Over the past 20 years, Pinyo have enjoyed a diverse career as an investor, entrepreneur, business executive, educator, and financial literacy author.

Leave Your Comment (18 Comments)

  1. Mike says:

    I’ve been told by experienced investor and mortgage broker that once you’ve been a landlord for 2 YEARS the lender will count the rent revenue, not just the debt payments. Need two years of tax returns. I think this falls under self-employment income in the guidelines.

  2. Pinyo says:

    I don’t have a rental property but do have some self-employment income and recently got a mortgage. I can tell you that they are a lot tougher now than they used to be. Like you, I wasn’t able to use current self-employment income to help my situation — the lender only used information from last year tax return and current full-time employment income.

    If you show no profit from previous year, their logic is that you’re not going have any profit this year either.

    You can always check out other mortgage lenders and see if it helps.

  3. BUTCH says:

    I applied for a home equity loan at a local credit union and was denied based on a DTI of 50%. I own a rental property which i make payments on of $1000.00 per month (owe 90K), but take in $2000.00 a month in rental income. I also have a mortgage payment on my home. These two mentioned is all the debt i owe. The lender stated the debt on the rental property was the reason my DTI was to high. I asked why the income, 24K, per year was not used in the calculation, but only the debt. I was told because i didn’t show a profit on the rental unit. For the life of me i can not understand this logic. The rental income pays for the debt no problems.

    Can you help me understand why they use only the debt and not the rental revenue in their calculation? A mortgage broker i know told me the rental income should be used in my favor and this lender just doesn’t want to give up the cash!

  4. Daniel North says:

    This post is really very appreciable. Your post is very advantageous for me and very good.

    I hate to say it, but you win some and you lose some. I am not saying that you’re wrong to write off as much as possible to reduce your taxes. But when you write off a lot to lower your income, this is one of the consequences. It seems like that’s your best bet since prepayment won’t help you when the teaser rate expires.

  5. Pinyo says:

    @Pamela – Thank you. Have you consider other lenders? Do you know of any bank that works specifically with self-employed and freelancer?

    Have you checked out this site? http://www.freelancersunion.org/

  6. Pamela Hanes says:

    There is a slight chance we will have the funds needed but my husband really doesn’t want to go that route. I, on the other hand,think that 4.75% is a great rate and don’t want to risk losing that offer. When we add up closing costs and the pay down amount it is closer to $30,000. We even adjusted our write offs this year and are paying twice as much per quarter as we were last year but it probably won’t make a difference. Until we know for sure we can access the extra funds needed, I may shop around a bit more. Thank You for your input. This site was very helpful.

  7. Pinyo says:

    @Pamela – I hate to say it, but you win some and you lose some. I am not saying that you’re wrong to write off as much as possible to reduce your taxes. I would do the same in your situation. But when you write off a lot to lower your income, this is one of the consequences.

    It sounds like you’re in ARM now and want to refinance to a fixed rate at 4.75%. Could you come up with the $20,000? It seems like that’s your best bet since prepayment won’t help you when the teaser rate expires.

  8. Pamela Hanes says:

    I am completely frustrated! Wanting to take advantage of the low rates we applied for a fixed mortgage. (In an ARM) We have great credit, little to no debt, still have quite a bit of equity in our home and two incomes. However, we are both self -employed and have a great CPA who writes off as much as possible for taxes. So when it comes to our adjusted income our DTI shows us at 52%. Why can’t they consider that self-employed people write off as much as possible to avoid paying too much in taxes! It is obvious that we can pay the mortgage, in fact at the proposed rate of 4.75% we would only be paying $120 more than we pay now which we have been paying on time for 4 years! This particular lender wants us to “pay down” our existing loan by at least $20,000 so our DTI will be 50%. Again, so frustrating! Oh and for some reason we don’t qualify for the Govt.’s Fannie Mae project!

  9. Jonathan says:

    Pinyo, you’ve just summarised in a nutshell what a financial adviser this week tried to explain to me in 40 minutes! Thanks for the post

  10. king tom says:

    Spend less, save more, enjoy life. Everything else is secondary. If you’ve got yourself into debt, stop spending. That should always be the primary advice.

  11. Pinyo says:

    I don’t think frugality matters in term of DTI. It’s a straightforward mathematical calculation. Frugality only matters in a sense that you may be able to pay your debt down faster if you are frugal, thus improving your DTI.

  12. Minimum Wage says:

    Since rent is half my income, my ratios are toast right off the bat.

    If you’re going to be broke the rest of ytour life, how important is frugality? Does it make a huge difference whether you die with $X debt or $2X debt?

  13. fathersez says:

    We use the back ratio, all debt payments against gross income.

    Banks here consider 33% as the maximum for a credit worthy person.

    We computed ours late last year and it was at the “yikes” level.

    I think I should have computed this every time we considered a loan.

  14. King of Debt says:

    At one point, before we started paying off our debt, our DTI was reversed. So basically the amount of money that we were paying out was less than we were bringing in. That was a fun time .

    The thing with DTI, is that it doesn’t really matter how frugal you are. The fact is that you have a high amount of debt compared to your income. While being frugal helps you pay it all off every month, the bank still sees that high amount of debt, and worries that you may not be able to pay it off one day.

  15. Mr. Stubbs says:

    this is definatley an interesting topic my partner an i have just purchased our first property and neither earn a huge amount but we live frugally. are we looked a favourably because we have the property? or negative because we don’t spend much on anything else except essential?

  16. Minimum Wage says:

    I read some of the Prosper discussion forums and got the impression that lenders look unfavorably toward people with very low incomes, no matter how frugal they are.

  17. Minimum Wage says:

    Shouldn’t frugality be worth something? A frugal person with a high DTI ratio can have greater capacity and be a better risk than a non-frugal person with a lower DTI ratio.

  18. Mrs. Micah says:

    I agree, MW. But I’m afraid it’s hard to prove frugality. I think that’s the benefit of Prosper and such. Tricia at Blogging Away Debt, for instance, was able to share her blog with people who might want to fund her. Technically it’s not proof of her frugality because bloggers can lie or mislead. But if she’s telling the truth (which I assume she is) she’s certainly the kind of person you want to lend to.

    But banks are less likely to accept that kind of thing.

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