How to Calculate your DTI and How It Affects Your Purchasing Power?

DTI stands for Debt-to-Income and is a ratio that shows what your debts are relative to your income.  It is a very common reason why some mortgages do not get approved.

The first step in calculating DTI is adding up all of your monthly debts that are reported on your credit report. Examples include other mortgage loans, car payments, credit card debt, student loans, and other finance programs. Keep in mind that you will use your minimum payment to calculate. The credit report will show several pieces of information about that debt. These can include the type of debt, current balance, initial balance, monthly payment, creditor, as well as payment history. Once all your monthly bills are added up you divide that number by your gross monthly income.

For example, let’s say we have a prospective mortgage payment of $1,500, a car payment of $300, student loan payments of $200, and a credit card minimum payment of $20. You would add these up to figure out your minimum monthly debt obligations.

                              $1,500 + $300 + $200 + $20 = $2,020

Now let’s say that you have a salary position and that pays you $5,000 a month. You would take your monthly debt obligation and divide that by the income.

                              $2,020 / $5,000 = 0.404.

After you calculate, you can see that you get 0.404; expressed as a percentage you would move the decimal point to the right two spaces giving you a DTI of 40.4%. For most mortgage programs, a DTI under 50% should qualify you for a mortgage loan.

Another common question that I get asked is “What if I have rental properties, can I use that income to offset an unfavorable DTI?”. The answer is “Absolutely” but it is not as simple as you might think. To incorporate your rental income into your DTI there are a couple extra steps we need to take.

Let’s say that you have another property and it gives you a monthly rent of $1,200, assuming this is the gross rent, meaning that this is rent before any deductions, expenses, or taxes. Let’s also assume that this property is paid off so we do not have to increase our monthly debt obligation due to a mortgage payment on the rental for ease of calculation.

Lenders make an assumption of a 25% vacancy rate meaning we can only use 75% of the rental income. A vacancy is a period of time where there are no tenants living in the property and thus affecting your income because no one is paying rent andit is a real factor that should be calculated. If you’re lucky enough to find a property that never has any vacancies, please call me and we can work out a deal. The lender uses 75% of the gross income because that is a conservative expectation for vacancies. Now that we know the calculation for vacancies, we can get a pretty good idea of how much income we can actually use.

For example, we take the gross monthly rent of $1,200 and we multiply by 75% or 0.75.

                              $1,200 x 0.75 = $900.

The monthly income that we can include into our DTI calculation is $900.

Now let’s take a look at our original DTI of 40.4%. Instead of an income of $5,000 due to our earned income only, we can increase that amount to $5,900. Now let’s calculate our new DTI.

                              $2,020 / $5,900 = 0.34 = 34%

Now our new DTI ratio is 34%. All because we were able to include our rental income!

There is one last common issue I would like to address. Some people get confused about how to calculate monthly income since most people get paid either weekly or bi-weekly instead of once or twice a month.

If you get paid weekly, you would take your weekly paycheck and multiply by 52. This is because there are 52 weeks in a year. To calculate our annual income based on your weekly income we will assume a weekly income of $1,250.

                              $1,250 x 52 = $65,000.

Now that we know the annual income of $65,000, we can now divide that amount by 12, since there are 12 months in a year, and find our monthly income.

                              $65,000 / 12 = $5,416.67.

Your new monthly income is $5,416.67.

Now we will go over how to calculate your monthly income if you get paid bi-weekly (every two weeks).

Let’s assume a bi-weekly paycheck of $2,600. You would take that amount and multiply by 26. If you get paid every 2 weeks, there are 26 pay periods in the year.

                              $2,600 x 26 = $67,600.

Now that we have calculated your annual income with bi-weekly paychecks, you would finish the calculation the same as we did before, by dividing the annual amount by 12.

                              $67,000 / 12 = $5,633.33.

For this calculation your monthly income would be $5,633.33.

Now, you might be asking me, “If I get paid bi-weekly, why can’t I just multiply by 2 and get my monthly, or why can’t I just multiply my weekly paycheck by 4?” That’s a great question and it is one that I get all of the time.

You can not simply multiply your bi-weekly paycheck by 2 because if you did that you are actually not accounting for an entire month of pay. With that calculation you would only be accounting for 24 pay periods, instead of 26. This leaves an entire month’s worth of income unaccounted for. Let’s use the same bi-weekly paycheck amount to calculate this to see the difference.

                              $2,600 x 2 = $5,200

                              $5,200 x 12 = $62,400.

You can see that we get $62,400, instead of our original $67,600. That’s a $5,200 difference.

Do not forget, you can never calculate monthly income with weekly or bi-weekly paychecks unless you first calculate the annual income, then divide by 12. For bi-weekly paychecks, multiply by 26 to get your annual income, for weekly paycheck, multiply by 52.

I hope this clears thing up and makes you more confident when discussing your DTI and mortgage eligibility with your loan officer in the future.