The debt-to-income ratio in real estate is a financial metric lenders use to assess a borrower’s ability to manage monthly loan payments. Keep reading to learn how a debt-to-income ratio (DTI) is calculated, how it is used, and what the ratio means for your real estate clients.
Understanding Debt-to-Income Ratio
Lenders use a borrower’s debt-to-income ratio to assess their ability to make their loan payments. Here are more in-depth reasons why this financial metric is carefully considered during the loan process.
1. Risk assessment
Lenders use DTI to evaluate the level of financial risk associated with a loan. A high DTI indicates that a significant portion of the borrower’s income already goes to payments, leaving less room for additional financial obligations.
2. Loan eligibility
Lending institutions often have maximum DTI ratio limits for loan approval. Borrowers with lower DTI ratios are considered less risky and more likely to qualify for loans.
Keep in mind that mortgage products have varying DTI ratio thresholds. Borrowers with a high DTI may have to pay more for their loans because they are at a higher risk of defaulting.
3. Financial stability
A person’s DTI ratio provides insight into their financial stability. It shows the borrower has enough income to cover their debts.
4. Affordability
A lower DTI ratio indicates that a potential borrower has more disposable income after meeting debt obligations. This can indicate that the borrower is better positioned to afford a mortgage payment.
5. Responsible lending practices
Assessing a loan candidate’s DTI is part of responsible lending practices.
6. Regulatory compliance
Sometimes, lenders may be required to adhere to regulatory guidelines that include specific DTI ratio limits.
DTI Ratio Formula
The DTI ratio is calculated by dividing the borrower’s total monthly debt payments by their gross monthly income. The result is expressed as a percentage.
DTI= Total Monthly Debt Payments/Gross Monthly Income x 100
Types of Debt-to-Income Ratios
There are three common types of DTI: front-end DTI, back-end DTI, and overall DTI.
1. Front-end DTI
The front-end DTI considers only housing-related expenses, such as mortgage payments, property taxes, and homeowner’s insurance.
2. Back-end DTI
The back-end DTI includes all monthly debt obligations, including credit card, car, and student loan payments.
3. Overall DTI
Just as the name implies, the overall DTI considers all debt.
What Documents Do I Need To Determine a Debt-to-Income Ratio?
A loan applicant must submit the following documents:
- Pay stubs
- Tax returns
- Credit reports
- Loan statements for existing loans (mortgages, auto loans, personal loans, student loans)
- Bank statements
- Monthly bill statements (utility bills, insurance bills, etc)
- Documentation regarding child support or alimony payments
Lenders use these documents to get a full financial picture of the loan applicant.
FAQs on Debt-to-Income Ratios
Homebuyers may be concerned that their DTI is too high for a mortgage. Here are some questions concerned homebuyers might ask of their real estate agents.
What is a good debt-to-income ratio?
Most lenders consider 36% an acceptable overall debt-to-income ratio and 28% a healthy front-end DTI. However, the DTI is one component of a person’s financial metrics.
How can I lower my DTI ratio?
Increasing your income, paying off debt, and avoiding new debt are ways to lower your debt-to-income ratio.
When you get your real estate license, you must be ready to answer many real estate questions, including “What is debt-to-income ratio in real estate?” Colibri Real Estate will help you answer these types of questions – and much more.
When you enroll in pre-licensing courses with Colibri Real Estate, you will learn information vital to help you pass your state-specific real estate exam. However, you will also learn what you need to know to offer the best service to your future clients. Colibri Real Estate is also dedicated to providing practical guidance to help you grow your career.
Start your real estate journey by learning the licensing requirements in your state.
Editor’s note: this post was originally published on January 31, 2024 and updated on January 31, 2024.
Author:
Gary Farris
Gary obtained his California broker’s license in 2007 and, in 2016, he earned his Arizona real estate broker’s license. He also began instructing part-time at the Arizona School of Real Estate and Business (ASREB) in July 2016. With Colibri Group’s acquisition of ASREB, Gary’s real estate instructor responsibilities expanded to Colibri Real Estate and its largest California brand, Allied Schools. In 2019, Gary was named the Arizona Journal of Real Estate’s educator of the year. In 2022, he earned a Distinguished Real Estate Instructor (DREI) certification, as well as a Certified Distance Education Instructor (CDEI).
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