What is Debt to Income Ratio

When applying for any sort of loan you will probably hear the term “debt-to-income ratio” mentioned more than once.  Lenders don’t necessarily set out to make this a mysterious term, but they use it so often than many times they don’t think to explain it to the borrowers.  Your debt-to-income ratio tells the lender how much of your monthly income is tied up with recurring financial obligations.

Lenders use this ratio to tell them if you are in a financial position to take on more debt.  Figuring out your debt-to-income ratio is quite simple.  First, figure out the total monthly amount of all your recurring bills.  Car loans, student loans, and credit card payments are the sorts of things you should include here.  Don’t include rent because they are looking for your debt-to-income ratio as it will relate to a new mortgage payment, not how it looks right now.  After totaling up all your monthly obligations, subtract this sum from your total monthly income.  You can generally use your pre-tax income since that is how most lenders look at the ratios.  Take this new number and divide it by your monthly income. This gives you your debt-to-income ratio. 

For example, a person who makes $5000 a month and has $2500 in monthly debt will have a debt-to-income ratio of .5, or 50%.  Incidentally, this is a pretty high ratio and most credible lenders would not write a mortgage in this instance.  35% debt-to-income ratio is usually the highest “A” lenders like to see.  “A” lenders are those who have low interest rates and who also do not charge many junk fees.  If at all possible, you should attempt to get a mortgage through this sort of lender; it will save you a lot of money in the long run.