A debt-to-income ratio is one of the more important terms for borrowers to know and understand. It is used during the application process for a variety of loan products to determine whether a specific applicant will reasonably be able to make payments.
Because the debt-to-income ratio is such a critical part of lender approvals, borrowers should understand exactly what goes into the calculation.
Too often, people hear “debt” and think it’s just credit cards and car loans, only to find out later that there are multiple components included in the calculation that they had not considered.
How is debt to income calculated?
Simply put, your debt-to-income (DTI) ratio is the amount you owe each month (your debt) divided by the amount you earn each month, before taxes (your gross monthly income).
This will yield a percentage, which is your DTI figure.
Lenders will take this number into consideration when you apply for a loan, as it is an indicator of how reliably a borrower will be able to make payments on time. The higher an individual’s monthly debt payments are, the higher their DTI percentage will be.
Which debts are typically included in a DTI (and which ones aren’t)?
Not every expense you have is included in a DTI calculation. This might seem counterintuitive at first. After all, every expense a household has in some ways can affect its ability to make monthly payments.
However, DTI is primarily focused on a household’s debt load and the resulting monthly payments. Here are some examples of fixed monthly payments that are included in a DTI calculation:
- Monthly vehicle payments
- Student loan payments
- Alimony and child support payments
- Credit card balance payments
- Housing costs, such as rent or mortgage payments
- Other debts
These are all monthly recurring expenses that typically do not vary from one month to the next. They are fixed, monthly payments made to service debts.
That is in contrast to other expenses a household is likely to have that are recurring, but not tied to debt. Here are some figures that are NOT included in a DTI calculation:
- Groceries
- Energy bills
- Cable/internet/mobile phone bills
These items are all important household expenses, but they are not debt repayments. And you can make decisions that reduce your grocery bill or your monthly energy bill.
So, while these are important figures to keep in mind as you budget, they are not part of your DTI calculation figure.
Is homeowners insurance part of the DTI calculation?
Yes, homeowners insurance is part of the calculation. Your monthly housing costs are included, and homeowners insurance is a key part of that total.
Housing costs are bundled into a separate acronym that includes the principal, interest, taxes, and insurance (PITI).
Although homeowners can sometimes choose to pay their property taxes and homeowners insurance bills separately from their mortgage payment, for the purpose of calculating DTI they are combined.
Because homeowners insurance is required by lenders as a condition of receiving a mortgage loan, it makes sense to include that figure in a DTI calculation. It is a fixed part of your monthly debt payment.
How is the DTI calculation used by lenders?
Lenders use debt-to-income figures to assess a borrower’s ability to comfortably pay each month. Lenders will have different thresholds and DTI requirements, particularly on the amount assessed to housing (known as a “front-end” DTI) and the amount assessed to all debt (total DTI).
Typically, a total DTI figure of 36% or lower is considered ideal.
If you have a higher DTI figure, you may still qualify for the loan you are hoping to secure. However, your bank may ask you to meet some additional eligibility criteria.
Are there ways to lower my homeowners insurance costs?
As homeowners insurance is part of your DTI calculation, finding ways to lower your premium may help you get to an ideal DTI figure.
Talk to your insurance agent to see if there are any discounts you may qualify for, such as bundling. Bundling your homeowners and auto insurance policies is a great way to save money1, and a lower premium cost would likely have a positive impact on your DTI calculation.
Other discounts could include loyalty discounts for long-time policyholders, along with being claims-free for a number of years. “Smart home” features such as automatic leak detection and security systems can also yield savings.
Choosing a higher deductible means that you are willing to shoulder more of the out-of-pocket costs if you ever need to file a claim, and it typically means a lower premium amount. Just make sure that whatever deductible you settle on is one that you would be able to pay.
Comparing homeowners insurance policies
Shopping around can yield savings on your homeowners insurance policy. Having a “set it and forget it” mindset could mean that you are paying more for your homeowners insurance policy than you need to, even for similar coverage.
If the idea of doing the work to compare insurers isn’t something you want to tackle alone, contact the experts at Rate Insurance. With access to a wide range of insurers, Rate can do the work for you, finding options that meet your needs and your budget.
Disclaimer:
All information provided in this publication is for informational and educational purposes only, and in no way is any of the content contained herein to be construed as financial, investment, or legal advice or instruction. Rate Insurance does not guarantee the quality, accuracy, completeness or timelines of the information in this publication. While efforts are made to verify the information provided, the information should not be assumed to be error free. Some information in the publication may have been provided by third parties and has not necessarily been verified by Rate Insurance. Rate Insurance, its affiliates and subsidiaries do not assume any liability for the information contained herein, be it direct, indirect, consequential, special, or exemplary, or other damages whatsoever and howsoever caused, arising out of or in connection with the use of this publication or in reliance on the information, including any personal or pecuniary loss, whether the action is in contract, tort (including negligence) or other tortious action.
1Savings, if any, vary based on individual insurance profile, coverage selections, prior carrier, and other factors. Not all applicants will qualify for lower premiums.
