PORTLAND, Maine — When lenders are considering any loan application, they look at the debt the borrower is carrying; so how do we best prepare ourselves to take on a new cost like a mortgage or car payment? Brenda Pollock, a financial counselor with Evergreen Credit Union, has a few tips.
Brenda, how are lenders looking at debt before approving a loan?
Lenders use the Arcanum DTI which stands for Debt to Income. It’s a personal finance measure that comprises an individual’s monthly debt payment to his or her monthly expenses. DTI is important for a borrower to know and understand before applying for a any new loan.
How do we know what our DTI is? Is this something we can figure out on our own?
It’s easy.
1. Total up your minimum monthly consumer debt: mortgage, credit cards, student loans, any debt that you make payments on. For this exercise, use the minimum monthly payment, even if you’re paying more than the minimum amount due.
2. Add up your total monthly gross income: That’s the money you’ve earned before taxes and deductions are taken out.
3. Divide your debt payments by your take home pay. For example, if your total monthly debt is $3,000 and your gross monthly income is $6,000, you would divide 3,000 by 6,000 to get .5 or 50%. Here's a look at different outcomes...
Let's say your DTI comes to 15%: You likely have little problem paying bills and managing other expenses.
35%: You most likely have money left over for savings or spending after you've paid your bills. This is favorable to lenders.
45%: You are close to, or in the danger zone for debt. Nearly half of your take-home pay is going towards paying for things you bought in the past.
50% or higher: This is considered too much debt. If you are in this range, lenders may limit your borrowing options.
Once we’ve calculated DTI, what’s the number we should be looking for?
With spring around the corner and lots of folks hoping to purchase a home, in general, 43% is the highest DTI you can have and still get a Qualified Mortgage.
Your income is not included in your credit report, so your DTI never affects your credit report or your credit score. However, lenders calculate your DTI when deciding to offer you credit. That’s because DTI is considered an indicator of whether you’ll be able to repay a loan.
You've mentioned two types of DTI: front-end and back-end, what are the differences?
Front-end DTIs examine only how much of your gross income goes toward housing costs; including mortgage payments, property taxes and homeowner's insurance.
Back-end DTIs compare gross income to all monthly debt payments, including housing, credit cards, automobile loans, student loans and any other type of debt.
Homebuying season is upon us, so who do you recommend for someone hoping to improve their Debt-to-Income ratio?
1. Focus on reducing your total debt. Pay off or pay down credit cards, and any other loan you may have.
2. Avoid taking on new debt.
3. Improve your income by asking for a raise, getting a second job or starting a small side business.
Lenders use DTI, along with credit history, to evaluate whether a borrower can repay a loan. Each lender sets its own DTI requirement. Personal loan providers generally allow higher DTIs than mortgage lenders.
American household debt hit a record $13.21-trillion in 2018. The bottom line is that when you charge a purchase or take out a loan, you are borrowing from two people: the lender and your future self.