What is DTI Ratio?
DTI ratio or Debt-to-income ratio is a measure of a person’s ability to pay back a particular loan. This ratio is used by banks and various money lending companies to check if a loan applicant should be granted a loan or not. It takes into account the person’s gross monthly income and his/her monthly liabilities.
For a person who earns 8000 US dollars monthly with 2000 USD as liabilities, he will have a DTI ratio of 25%. This figure is computed by dividing the person’s total monthly liabilities over his/her total monthly income. With this DTI ratio, this particular person may or may not be granted a loan by a bank or mortgage lender. As the DTI ratio qualification may differ between banks and other lending companies. On average though, the maximum DTI ratio acceptable is around 40-50%. What’s usually calculated as part of a person’s liabilities are mortgage payments, home insurance premiums, taxes, and other expenses related to the household?
The Debt-to-Income ratio may also be classified into two types: front-end and back-end. Front-End DTI ratio calculates the total household related expenses such as rent, mortgage, and insurance as the basis for a person’s liabilities. Back-end DTI meanwhile includes other recurring expenses as part of the liabilities. These recurring expenses could be credit card payments, school tuition fees, and car loan premiums, among others. So with the example above, if 1500 USD are mortgage payments and the other 500 are car premiums, one will have a front-end DTI of 18.75% and back-end DTI of 25%.
DTI ratios are very helpful for both parties involved namely the person/s applying for the loan and the money lender. For loan applicants, this ratio is a great indicator of financial health. Lower ratios are considered great ratios because it indicates that a particular person does not have too many liabilities. For the money lenders on the other hand, the DTI ratio gives them basis on which people are able to re-pay a particular loan.