Debt To Income Ratio

DTI or Debt To Income Ratio. This is one formula an investor needs to master if they want to generate unlimited wealth buying real estate with bank financing. What is it? Well Wikipedia defines it as:

Debt-to-income ratio is the percentage of a consumer's monthly gross income that goes toward paying debts. It is usually expressed as two numbers. The first number indicates the percentage of income that goes toward paying off a mortgage principal and interest, mortgage insurance, hazard insurance, property taxes, and homeowner's association dues. The second number indicates the percentage of income that goes toward paying all recurring debts, including those covered by the first number, and other debts such as credit card payments, car loan payments, and child support payments.

My Definition: Your key to unlimited wealth. Most lenders like to see a DTI of less than 45% for a borrower who is financing investment property. How its calculated is simple:

Income: Monthly Gross Salary + other monthly income + net rental income (we will discuss this more below)

Debt: The total Monthly car payments, minimum credit card payments, rent or mortgage payment on your personal residence, any other installment loans.

DTI = DEBT / INCOME x 100

A couple of important notes. Net Rental Income is calculated on a per property basis. Its calculated as follows:

Net Rental Income = (.75 x Gross monthly Rent) - (PITIH)

Some lenders use 75% of Gross Monthly rent, others use 70%. Like everything else with Banks, it varies.

Whats PITIH? It stands for Principle Interest Taxes Insurance Home Owners Assoc. Basically its your total monthly payment including escrows. Now Listen close. If you are using a product like an Option ARM, the PITIH a lender uses to calculate your DTI is the minimum payment option. Much like the minimum payment on a credit card, only the minimum payment option on your loan is used. I like Option ARMS. They help keep my DTI nice and low.

Back to Net Rental Income. If the Net Rental Income is possitive, then add it to your total monthly income. If its negative, subtract it. Simple huh? It is really.

So what does it all mean? If you buy and finance an investment property with a possitive Net Rental Income, your DTI improves. If you keep your DTI under 45%, the only thing that will stop you from owning more investment property is your lack of wanting more.

My advice to you: Know the rules of the game before you play. If you do not know them, find someone who does. It will make your investing experience much easier.