Debt-to-Income (DTI) Ratio

When evaluating an investment property, using rental metrics and analytics is crucial for making informed decisions. Metrics provide a clear picture of a property’s current or potential financial performance, helping investors gauge profitability and mitigate risks. Debt-to-income ratio is one metric that can help investors optimize their portfolios, ensuring they make the most out of their real estate ventures.  

What is a Debt-to-Income Ratio? 

Simply put, your debt to income (DTI) ratio is a percentage that signifies how much of your monthly gross income goes toward monthly debt payments. In real estate, this is most likely to involve paying off mortgage debts, though we will discuss later in this article the importance of also considering any other personal loans and outstanding debts into your calculation. 

For example, if you are dedicating a quarter of your gross monthly income toward paying off your outstanding debts, that is a DTI ratio of 25%. Calculating your DTI ratio will not only give you a new perspective on your current debt burden, but it can also help you determine whether you are qualified for any new loans. 

DTI Ratio Formula 

The formula for debt-to-income ratio is as follows: 

DTI Ratio = (Total monthly debt payment / Gross monthly income) * 100

Using these variables, you will be able to keep track of the kind of financial habits you need to maintain to be eligible for certain loans. 

When to Use DTI Ratio 

While the percentage you get from this formula can be a good indicator of your overall financial health, the primary use for this data is to help you acquire a loan. If your ratio is low and looks good to a lender, you may be able to take on additional debts and monthly payments without too much financial stress. If your numbers do not look ideal, the number is still valuable in helping you determine what factors you may be able to adjust to improve it. 

How to Use the DTI Ratio Calculator 

Innago’s free debt to income ratio calculator is designed to help you quickly assess your eligibility for certain loans by comparing your current debts to income level. While on its surface the DTI ratio formula may seem straightforward, there are many considerations for the included variables to ensure it is a precise and usable calculation. Let’s get into what is included in each of the equation’s variables. 

Inputs 

There are only two inputs involved in the DTI ratio calculation: 

1. Total monthly debt payments 
2. Gross monthly income 

Your total monthly debt payment is the sum of all your outstanding debts. If you own a home, your mortgage loan is likely the largest contributor towards your debt. However, your outstanding debts also include student loan payments, car payments, credit card debt, personal loans, and any other kind of debt you may have. When lenders begin the underwriting process, they evaluate you holistically as a borrower. Even if your mortgage is paid off, your DTI ratio could indicate that you’re a riskier borrower if you have substantial bad debt, such as credit card debt or personal loans. 

The other input in this equation, gross monthly income, is much more straightforward. The denominator of the fraction should include all of the income that you earn in that respective month, excluding any overhead such as taxes, expenses, or—most importantly—debt payments. 

Outputs 

The output in this equation is your DTI ratio, which will tell you the ratio of your gross monthly income that went toward paying off any outstanding debts.  

How to Interpret Your DTI Ratio 

DTI ratio may be used as an assessor for your current financial health. A relatively low DTI ratio communicates to you as well as potential lenders that your income is sufficient and you are responsible enough to cover your ongoing debts, making you a more ideal candidate for a loan. A higher ratio may communicate either that you are not making sufficient income to cover your debts or are not allocating enough of your monthly income toward relieving your debts. Either way, the percentage you produce is one that is likely to be significant to any lenders. 

According to Investopedia, the maximum DTI ratio that most lenders will accept for mortgage applicants is 43%; however, most lenders prefer less than 36%. 

There are two ways to improve your DTI ratio: You can either increase your income or decrease your debt. If you’re looking to lower your ratio, prioritize eliminating high-interest debts by making more than the minimum payment on your mortgage payments. This could come at the expense of other monthly bills, but you’ll be able to limit the accrual of interest and minimize your total outstanding debt. Be sure you are making minimum credit card payments each month and limit other types of high interest debt like personal loan debt.  

Lastly, remember that mortgage lenders look at the holistic picture of your financial situation. Even if you could reasonably take on a mortgage payment, other factors like your credit history or property taxes payment history could interfere with your ability to secure a new loan. 

Conclusion 

As we have seen, the DTI ratio equation that looks simple on its surface has a number of considerations. Take advantage of Innago’s free DTI ratio calculator and use it to help determine your eligibility for a future loan or investment.