Understanding Debt-to-Income Ratio
When it comes to applying for a mortgage, one factor that a lot of lenders consider is your debt-to-income (DTI) ratio.
This ratio provides insight into your financial health by comparing your total monthly debt payments to your gross monthly income.
Understanding and managing your DTI ratio can impact your ability to secure a mortgage. We explain what DTI ratio is, how to calculate it, and why seeking advice from Kerr & Watson can help you navigate this essential aspect of mortgage applications.
What is Debt-to-Income Ratio?
The debt-to-income ratio is a financial metric used by many lenders to assess your ability to manage monthly debt payments and repay loans.
It is expressed as a percentage and calculated by dividing your total monthly debt payments by your gross monthly income.
A lower DTI ratio indicates a healthier balance between debt and income, making you a more attractive candidate for lenders. Not all lenders have a threshold to approve a mortgage but many do, even if they do not publicly publish this amount.
How to Calculate Debt-to-Income Ratio
Step-by-Step Calculation:
Calculate Monthly Debt Payments:
- Sum up all your monthly debt payments. This includes mortgage payments, credit card bills, vehicle finance, personal loans, overdrafts, student loans, and any regular maintenance or financial support payments.
Determine Gross Monthly Income:
- Calculate your total gross monthly income, which includes your salary, benefits, incoming maintenance payments, and any additional earned income such as bonuses or freelance work.
Calculate the DTI Ratio:
- Divide your total monthly debt payments by your gross monthly income.
- Multiply this number by 100 to convert it to a percentage.
Example Calculation:
- Total Monthly Debt Payments: £1,400
- Total Gross Monthly Income: £4,500
- DTI Ratio: (1400 / 4500) * 100 = 31.1%
If it’s easier, we would recommend contacting a mortgage adviser who can collect all information about your debts and income to assess your DTI ratio. They can then work out which lenders may be available to you.
If you are unsure about your debts and payments, you can request a copy of your credit file from CheckMyFile.
Find out Your Options
What Counts as Debt?
Credit Card Bills
Minimum Payments: A rule of thumb is to calculate using 1.5 times your monthly minimum payment to reflect a more realistic commitment to debt reduction.
Vehicle Finance
Car Loans and Leases: Include the total monthly payments for any car finance or lease agreements. Do not include insurance, road tax, or fuel costs.
Personal Loans
Unsecured Loans: Add the monthly repayment amounts for any personal loans from banks or other financial institutions.
Overdrafts
Overdraft Fees and Interest: If you regularly use an overdraft, include a monthly amount that covers the interest and fees, plus a portion of the overdraft balance.
Debt Management Payments
Debt Management Plans: Include payments towards any formal or informal debt management plans.
Other Debts
Miscellaneous Debts: This includes repayments to HMRC, benefit overpayments, or informal loans from family or friends.
What Doesn’t Count as Debt?
Certain expenses are not usually considered debt to lenders so unlikely to be included in your DTI calculation:
- Regular utility bills
- Mobile phone contracts
- Subscription services (e.g. gym and Sky Television)
- Food and transportation costs
- Health and life insurance premiums
Your Gross Monthly Income
To accurately calculate your DTI ratio, all sources of income should be included before any deductions such as taxes or pension contributions.
Earnings
Salaried Employees: Calculate your monthly income by dividing your annual salary by 12.
Self Employed Employees: Look at your tax calculations to assess how much you made in pre-tax profit as a sole trader or salary and dividends as a company director. How to get your tax calculations and tax year overviews.
Benefits
Child Benefit and Tax Credits: Include all benefits in your monthly income calculation.
Incoming Maintenance Payments
Child Support: Include any regular child support payments you receive.
Additional Earned Income
Supplementary Income: Add any additional earnings from bonuses, commissions, tips, or income from a second job.
Acceptable Debt-to-Income Ratio
Lenders prefer borrowers with lower DTI ratios, as they are seen as less risky. Here’s a general guideline:
0% to 19%: Very low risk, universally accepted.
20% to 29%: Good borrower, widely accepted.
30% to 39%: Acceptable risk, most lenders offer standard terms.
40% to 49%: Moderate risk, some lenders may require larger deposits or good credit history.
50% to 74%: High risk, fewer lenders with less favourable terms.
75% to 99%: Very high risk, only specialist lenders might consider.
100% or higher: Extremely high risk, much higher chance of rejection.
An important to thing to note, however, is that lenders all have their own rules around what is acceptable to them, and this differs across the market. To get a real idea of who may lend to you and what the terms may look like, you should speak with a mortgage advisor.
Why Seek Advice from Kerr & Watson?
Understanding and managing your DTI ratio can be challenging. At Kerr & Watson, we offer expert mortgage and protection advice tailored to your financial situation.
Whether you’re buying your first home or looking to refinance, Kerr & Watson is here to help. Our personalised advice ensures you make informed decisions and secure the best mortgage terms.
Reach out to us today for personalised advice and support for your mortgage.
