Why is this so important? Your debt to income ratio is all your monthly debt payments divided by your gross monthly income. This number allows lenders to measure your ability to manage your payments you make every month to repay the money you borrowed.
To calculate this, you add up all your debt payments and divide them by your gross monthly income. This is the money that you collect usually before taxes and other things that you have taken out such as, social security, in kind donations. For example, if you pay $2000 a month for your home and another $200 for an auto loan and $600 for the rest of your debts your monthly payments are $2800 ($2000+ $200+ $600 = $2800.) If your gross monthly income is $8000 then your debt-to-income ration is 35 percent. ($2800 is 35% of $8000)
Studies from mortgage loans say that borrowers that have a higher debt to income ratio are likely to run into trouble with making monthly payments
Lenders typically say the ideal front-end ratio should be no more than 28 percent, and the back-end ratio, including all expenses, should be 36 percent or lower. Depending on your credit score, savings, assets and down payment, lenders may accept higher ratios, depending on the type of loan you're applying for.
For conventional loans backed by Fannie Mae and Freddie Mac, lenders now accept a DTI ratio as high as 50 percent. That means half of your monthly income is going toward housing expenses and recurring monthly debt obligations.
Credit bureaus don't look at your income when they score your credit, so your DTI ratio has little to do with your actual score. But borrowers with a high DTI ratio may have a high credit utilization ratio -- and that accounts for 30 percent of your credit score.
Credit utilization ratio is the outstanding balance on your credit accounts in relation to your maximum credit limit. If you have a credit card with a $3,000 limit and a balance of $1,500, your credit utilization ratio is 50 percent. You want to keep that your credit utilization ratio below 30 percent when applying for a mortgage.
Lowering your credit utilization ratio will not only help boost your credit score but lower your DTI ratio because you're paying down more debt.