When you apply for a mortgage the lender will undertake various checks, to assess your credit worthiness and affordability.
One of these is a debt to income ratio calculation. This is quite a mouthful, but it’s actually quite simple to do this for yourself!
This article will explain what a debt-to-income ratio is, how lenders calculate it and how it affects how much you can borrow.
What is a debt to income ratio (and why it’s important)
A debt-to-income (DTI) ratio looks at how much you pay each month towards debts and credit facilities, compared to what you earn.
It is a standard measure that lenders use to work out whether someone will be able to afford their new mortgage payments.
It involves a simple calculation that produces a percentage (%) figure. This is your DTI ratio.
This tells the lender what percentage of your earnings are committed to debt repayments and interest.
Ideally, you want the ratio figure to be low, you will then be classed as a lower risk.
If the DTI is too high then your mortgage could be declined, or accepted at a lower amount.
Before we can do the calculation, we need to work out your debt repayments and your monthly income
What counts as debt?
This will include all of your regular debt related monthly payments, such as your mortgage, personal loans, credit cards etc.
- Mortgage/Rent
- Personal loans
- Car finance
- Credit cards
- Student loans
- Bank overdraft
- Secured loans
- Hire Purchase/Interest Free
- Child maintenance
And what counts as income?
When calculating your Debt-to-Income (DTI) ratio, the income figure should represent your total gross monthly income before taxes and other deductions. Here’s what you should include:
- Gross salary
- Overtime
- Bonuses/Commission
- Self-employed income
- Second jobs
- Freelance work
- Incoming maintenance
- Benefit payments
- Stipend income
Does my debt-to-income ratio include my mortgage?
Yes, your new mortgage payments need to be included in the calculation, along with your loan payments, credit cards, HP etc.
You should now have two figures
Total debt payments
Total income payments
Calculating your debt to income ratio
Calculating your own Debt-to-Income (DTI) ratio involves two steps: adding up all your monthly debt payments and dividing that by your gross monthly income.
Here’s a step-by-step guide:
- Add up your monthly debt payments
- Calculate your gross monthly income
- Divide your debt figure by your income figure
This will give you a decimal number. To convert this into a percentage, multiply the result by 100.
DEBT FIGURE ÷ INCOME FIGURE x 100 = DTI %
QUICK EXAMPLE
£1000 DEBT PAYMENTS ÷ £3000 GROSS INCOME x 100
= 33.33% Debt to income ratio
What is a good ratio?
Every lender will have their own limit on what is acceptable. In the same way that they will have different tolerances for instances of poor credit or a low credit score.
A good starting point is getting your ratio below 50%, and lower if possible.
At 30% or below you will have a good choice between the most competitive lenders. As this figure increases, the number of available lenders will decrease.
Where your percentage is above 50% you are likely to need a ‘specialist’ lender, who will be more understanding of your credit commitments, but who will also want to charge you more interest for the privilege.
How important is the DTI ratio?
It is certainly important and should be one of the items you focus on when getting yourself mortgage ready.
But also there are other important aspects, such as:
- Credit score
- Types of debts
- Employment status
A good lender will look at all of these points, to form an overview of your situation, and the likelihood that you will be able to afford the repayments.
Debt-to-income and credit status
Your DTI ratio is not the same as your credit status or credit score.
Debt-to-income ratio
A simple calculation that looks at how much of your income you spend on debt servicing and repayment. It does not take into consideration issues with payments such as late payments or arrears.
Credit status
Your credit report and credit score are a reflection of what’s on your credit file and how well you have managed your credit agreements. Credit Reference Agencies don’t know how much you earn but they receive their data from lenders and companies that share financial data with them.
It is perfectly possible to have a high DTI percentage but with a good credit score. Or a poor credit score and a low DTI ratio.
How can a broker help?
Specialist advice
Mortgage brokers will know whether you have a good chance of gaining a mortgage. They can also give suggestions on how to improve your situation.
Lender research
A whole of market broker will have access to over 100 lenders. Some of these are more accepting of borrowers with a high DTI figure, and some don’t even do a DTI calculation.
Works for you
Your broker can speak directly to lenders on your behalf, and will be there to help with any problems or lender requests.
Ready to explore your options?
If you’re on the cusp of starting your mortgage journey and could use the guiding hand of a professional, don’t hesitate to reach out to a reputable mortgage broker.
They will make the process smoother and more profitable than going it alone. And remember, knowledge is power.
The more you know, the better decisions you can make. Keep reading, keep asking questions, and keep moving forward on your journey.
