First off, what is Debt-to-Income? The Debt-to-Income ratio is one used by lending institutions when underwriting your loan (for almost anything – car loan, mortgage, HELOC, etc). DTI is a calculation they use to  measure the risk on which you’ll be able to pay back the loan you’re seeking. The lower your DTI, the less risky you are to a lender. Think of it as your golf score, lower is better.

If you have just one source of income, DTI is fairly simple to calculate. Take your recurring monthly debt divided by your gross monthly income. Expenses like groceries, utilities, gas, insurance are not usually involved in this calculation. For example, let’s assume your current situation looks like this:

  • Reoccurring Monthly Debt: $2,030
    • Personal Mortgage/Rent: $1,000
    • Car Payment: $320
    • Total Credit Card Payments: $600
    • Student Loans: $110
  • Gross Monthly Income: $6,000

DTI = Reoccurring Monthly Debt / Gross Monthly Income or in this case:

DTI = $2,030 / $6,000 = 33.8%

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BUT WAIT, there’s more! What about the loan your seeking? Let’s say hypothetically the loan your seeking will add $700 more in monthly debt. Let’s recalculate as the lending institution certainly will.

DTI = $2,730 / $6,000 = 45.5%

Most lending institutions will consider you an acceptable risk if your DTI is less than 43%. Remember the lower your golf score, I mean DTI, the less risky you are to a lender.

BUT WAIT, there’s EVEN more! You and I are both here because of buy & hold real estate investing. So let’s assume you’re relatively new, have 2 properties in your portfolio and are seeking a loan for a 3rd property. DTI becomes increasingly more complicated to calculate the more properties and the more loans you have in your personal name but one of the reasons why I encourage you to build your team AND a solid relationship with a local bank is because it makes this process much easier as you start acquiring more and more properties. Using our original example, let’s do some more math!

  • Reoccurring Monthly Debt: $3,258
    • Personal Mortgage/Rent: $1,000
    • Car Payment: $320
    • Total Credit Card Payments: $600
    • Student Loans: $110
    • Rental Property #1 Mortgage: $415
    • Rental Property #2 Mortgage: $823
  • Gross Monthly Income: $9,625Gross W2 Income: $6,000
    • Gross Rents Property #1: $1,375
    • Gross Rents Property #2: $2,250

DTI = Reoccurring Monthly Debt / Gross Monthly Income or in this case:

DTI = $3,258 / $9,625= 33.8%

Making up the debt/income numbers as I go along, I found it extremely weird two of these examples both came out to 33.8%

By the way, check with your lending institution to ensure you understand their seasoning time frame. In this example, “seasoning” is how long a rental property has to be occupied to count the gross rents toward your DTI calculation. Most seasoning periods fall between 6-18 months but best to ask your lending institution what they require. In my examples, all properties are seasoned, except for the 3rd one you’re wanting to purchase.

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  • Reoccurring Monthly Debt: $3,258
    • Personal Mortgage/Rent: $1,000
    • Car Payment: $320
    • Total Credit Card Payments: $600
    • Student Loans: $110
    • Rental Property #1 Mortgage: $415
    • Rental Property #2 Mortgage: $823
    • Potential Rental Property #3 Mortgage: $722
  • Gross Monthly Income: $9,625
    • Gross W2 Income: $6,000
    • Gross Rents Property #1: $1,375
    • Gross Rents Property #2: $2,250
    • Gross Rents Property #3: $0 (once seasoned will be $1,700)

DTI = Reoccurring Monthly Debt / Gross Monthly Income or in this case:

DTI = $3,980 / $9,625= 41.3%

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Still under that 43% mark we’re striving for and if you have a great relationship with the bank and all other items check out, you should be on your way to close.

Also, gross rents minus the mortgage on a rental property does not equal cash flow. This is a common misunderstanding of the term and if you’re investing for cash flow, you need to ensure you’re calculating it accurately. More detail on cash flow here: REI Terms: Cash Flow.

In closing, DTI is just one factor a lending institute will consider when evaluating you and underwriting your potential next loan. Make sure your properties are seasoned properly when doing your own calculations but more importantly work on the relationship with your local bank to understand what all they require.

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