Last Updated on 07/22/2017 by GS Staff
Q:Is rent included in the debt-to-income ratio?
A:The debt-to-income (DTI) ratio is calculated by taking your total debts divided by your total income. The DTI ratio is used by lenders as a way to determine if you will be able to pay your monthly payments on a loan. Let’s take a look at how you calculate a DTI ratio.
DTI Ratio Calculation
Assume you have the following monthly debt payments and income. Also assume that you currently live with your parents. You are buying a new home and taking out a new mortgage to acquire the property.
- Citibank Visa: $50 per month
- American Express: $75 per month
- GMAC Car Lease: $325 per month
- Student Loan: $125
- New Mortgage Payment $1,325 (payment includes principal, interest, taxes, and insurance)
- Salary: $5,500 per month
- Bonus: $200 per month (you have consistently received this monthly bonus for at least two years and it is projected to continue)
Based on the above information, your DTI ratio would be 33 percent. This is determined by using the total debts of $1,900 per month divided by the total income of $5,700 per month.
Remember that it is Okay to have debts such as credit card payments, student loans, or various other liabilities. However, the lender must ensure that you are able to make payments on your existing debts while also being able to pay the new monthly mortgage payment. This is why the DTI ratio is so important to lenders.
Rent and the Debt-To-Income Ratio
Now that you understand how the DTI ratio is calculated, let’s look at how rent factors into this ratio.
Assume you are renting your current residence. You are sick of paying rent on this residence and wish to move into a new property where you obtain a mortgage to acquire this new primary residence. In this scenario, you do need have to include the rent payment in your DTI ratio since you will no longer be paying a rent payment once you move to your new residence. However, you do need to include the new mortgage payment that you are going to obtain in the DTI ratio.
Rent is included in your DTI ratio when you still plan on paying rent on a property after you obtain a mortgage. For example, you may rent your primary residence but wish to obtain a mortgage to purchase a secondary residence in a warm place that you visit in the winter. In this scenario, you would include your rent payment and the new mortgage payment on the secondary residence in your DTI ratio.
The key to whether to include your rent in the DTI is your intent. If your rent will continue for the foreseeable future, you must include it in the DTI ratio. If your lease ends, and you plan on moving in a new house, you do not have to include the rent but you must include the new mortgage payment.
Other DTI Ratio Considerations
Keep in mind the following key points when determining what debts to include in your DTI ratio. Each lender may have different guidelines but the below factors apply for many lenders or types of loans.
- Installment loans with ten payments or less generally do not have to be included in your DTI ratio.
- You must include student loans as a debt regardless if the loans are in repayment, deferred, or in forbearance. If the payment does not appear on the credit report, the lender may use 1% of the balance as the payment. You should likely provide the lender with the monthly payment information if you have the information available to you. The actual student loan payment is often less than 1% of the balance that the lender may use for qualification.
- Lenders can exclude non-mortgage debts that you are obligated to pay, but are actually being paid by another individual. The lender will likely require at least 12 month’s cancelled checks or bank statements showing another party is making these debt payments. The person making the payment cannot be an interested party in the loan transaction. Additionally, there typically cannot be late payments associated with the debt.
- Generally, loans secured to a asset do not need to be included as a debt. For example, a 401K loan does not need to be included as a debt since it is secured by the retirement funds in the account.
The above considerations are just some of the things you should consider when determining your DTI ratio. Again, mortgage lenders are not all the same and may have different guidelines from what was presented above. You should consider working with a loan officer or mortgage professional to help you with your particular situation.