Debt-to-income (DTI) ratio is a key financial metric for real estate investors, as it helps determine how much leverage an investor can take on when acquiring a property. The DTI ratio is calculated by dividing the borrower’s total monthly debt payments by their gross monthly income. The result of this calculation gives lenders an idea of how well the borrower will be able to manage their current debts and what they can feasibly afford to borrow from them. Lenders tend to prefer borrowers with a DTI of 36% or less, but this can vary.
When it comes to real estate investing, there are many different factors that go into settling on which properties are a right fit for your portfolio. One of the most important ones is the debt-to-income ratio, or DTI. This will become a top factor for you especially if you'll be utilizing lenders to finance your next rental purchase.
Debt-to-income (DTI) ratio is a financial metric used to assess the ability of a borrower to repay their mortgage. It is calculated by dividing the borrower's total monthly debt payments (including the proposed mortgage payment) by their gross monthly income. Lenders use this ratio as a way to evaluate the risk of lending to a borrower, as a higher DTI ratio may indicate that the borrower has a greater likelihood of defaulting on their mortgage.
A high DTI ratio can be a red flag for lenders, as it suggests that a borrower may have difficulty affording their mortgage payments. Lenders typically have a maximum DTI ratio that they will accept for a loan.
For example, a lender may have a maximum DTI ratio of 45%, meaning that a borrower's total monthly debt payments cannot exceed 45% of their gross monthly income.
In the case of rental properties, lenders also consider rental income as a form of income and this is included in the calculation of DTI ratio. This is known as debt coverage ratio or Debt Service Coverage Ratio (DSCR)
In order to calculate a debt-to-income (DTI) ration, you'll need two things: the total monthly debt payments, and the gross monthly income.
You can find total monthly debt payments by adding up all of your outgoing payments for each month. Such items can include:
Find gross monthly income by determining the total amount of money earned before taxes and other deductions are applied. Here's an inclusive (but not exhaustive) list of examples of what falls into this bucket:
Once you've arrived at the above numbers, simply divide the total monthly debt payments by the gross monthly income. The resulting percentage is the relevant DTI ratio.
With this in mind, let's now work through a quick example to make sure we understand how DTI is calculated:
Let's say you have a car loan payment of $300 per month, a student loan payment of $200 per month, and a credit card payment of $150 per month. Your total monthly debt payments would be $650 ($300 + $200 + $150).
If your gross monthly income is $5,000, you would divide $650 by $5,000 to get a DTI ratio of 0.13, or 13%.
Keep in mind that when calculating DTI for rental properties, rental income is also included as a form of income. So, if you have a rental income of $1,000/month and your total monthly debt payments is $650 as in above example, then your DTI would be $650/$5000+$1000 =0.13 or 13%.
Lenders typically have a maximum DTI ratio that they will accept for a loan. This ratio varies with the type of loan and lender. For example, a lender may have a maximum DTI ratio of 45%, meaning that a borrower's total monthly debt payments cannot exceed 45% of their gross monthly income.
It is important to note that a high DTI ratio does not necessarily mean that a borrower will be denied a loan. Lenders may consider factors such as the borrower's credit score, the down payment, and the type of property being purchased when evaluating a loan application. Additionally, some programs may have different guidelines for DTI ratios, such as FHA loans, which may allow for higher DTI ratios than conventional loans.
Debt-to-income ratio is a measure of a borrower's ability to repay a mortgage loan. It is calculated by dividing the borrower's total monthly debt payments by their gross monthly income, and is used by lenders to assess the risk of lending to a borrower. A high DTI ratio can be a red flag for lenders, but other factors such as credit score, down payment, and the type of property being purchased are also considered.