Pondering the DTI Ratio...thoughts?

4 Replies

Just a thought, and curious as to others' thoughts on this as well...

I've been thinking about the DTI (debt-to-income) ratio used in lending decisions. For those unfamiliar, lenders typically will not lend to a borrower with more than ~43% of their monthly income going towards recurring debt obligations (see here for an explanation of calculation). My assumption is that lenders have determined (based on research, statistics, etc.) that borrowers who have ~60% or more of their income available for expenses other than recurring debt obligations are more likely to be able to make all of their monthly payments.

My question for the BP community is - does anyone have knowledge of the source of the DTI calculation, such as the research/stats that justify it? I am curious how long it has been around, and if folks still feel this is an accurate portrayal of "ability to pay". It seems to me that our financial behaviors change over time and through generations, cultures, etc. and this could start to skew how representative the DTI ratio really is. For one example, some people charge all of their monthly necessities (groceries, transportation, etc.) to a credit card these days just for the points/rewards, but still might only spend what they have budgeted for based on their income, and pay these off immediately at the end of every month. So let's say Person A spends $600 on groceries, transportation, and entertainment this month. At some point in the month, this person's credit report is going to show that they owe some minimum amount to their credit card company (not the full $600, but some calculated minimum), which will be added to their monthly debts in a DTI calculation if a lender pulled their report at that time, even if they ultimately pay the entire balance at the end of each month. On the other hand, let's say Person B spent that same $600 on their groceries, transportation, and entertainment, but paid in cash or with a regular debit card, and therefore will not have that extra amount added to their DTI ratio. All else being equal, Person A will have a higher DTI ratio then Person B, but is Person A really a riskier borrower? Both are spending the same amount on the same commodities, and not carrying debt forward to the next month. Maybe some could argue that since Person A is deferring payments for things like groceries to the end of the month, he/she is more at risk for misjudging his/her spending than someone who sees the charges coming out of their savings or cash immediately. But I wonder if there is actually research to suggest this is true, or any other information on the relevance of the DTI ratio today, and thoughts on other financial behaviors/factors that might skew it's accuracy (recognizing that this is just one factor that lenders use in their decision making, of course). 

Just a random thought! Curious for other thoughts/opinions. 

@Anthony Gayden Yes I've heard this before as well, where lenders will make exceptions and go beyond their normal DTI limits. I think this demonstrates lenders' recognition that the DTI ratio isn't a hard and fast rule, and doesn't always show the whole picture. I'd be curious to learn more about what factors might cause lenders to bend these rules. For example, in your case Anthony - do you think your track record as a reliable borrower/mortgage holder gave your lender the extra reassurance to warrant that flexibility in the ratios?

You could always move away from standard bank financing and into private institutional money where your personal DTI is not a factor at all. Just a thought/solutions to problems with the DTI conundrum

Originally posted by @Samantha Miller :

@Anthony Gayden Yes I've heard this before as well, where lenders will make exceptions and go beyond their normal DTI limits. I think this demonstrates lenders' recognition that the DTI ratio isn't a hard and fast rule, and doesn't always show the whole picture. I'd be curious to learn more about what factors might cause lenders to bend these rules. For example, in your case Anthony - do you think your track record as a reliable borrower/mortgage holder gave your lender the extra reassurance to warrant that flexibility in the ratios?

 

Well I did a little research and it looks like the rules were changed by Fannie Mae.

https://www.creditkarma.com/home-loans/i/debt-to-income-ratio-increase/

"Fannie Mae, the leading provider ofmortgage financingin the U.S., is relaxing its debt-to-income ratio requirements to give more potential borrowers access to credit. The increase,which took effect July 29, allows borrowers to have a DTI ratio limit of 50 percent, up from 45 percent."