Understanding Auto Insurance: Dti's Role And Relevance

When applying for a mortgage, lenders will review your debt-to-income ratio (DTI) to determine the monthly mortgage payment you can afford. This ratio is calculated as a percentage by dividing your monthly debts by your gross monthly income. Notably, auto insurance is not included in the DTI calculation, which can be confusing for some, especially since homeowners' insurance is included. This exclusion is because auto insurance is not defined as a debt, and there is more flexibility in terms of car ownership, whereas homeowners' insurance is mandatory for those with a mortgage.

Why auto insurance is excluded from DTI calculations

Auto insurance is not included in DTI calculations because it is not defined as a "debt". It is considered nondiscretionary income, which is not included in the debt-to-income ratio. Lenders use the DTI ratio to assess a borrower's risk, and auto insurance does not affect the riskiness of the borrower.

The DTI ratio includes monthly payments such as mortgage, car payments, student loan repayments, and child support. It is used by lenders to determine how much house you can afford. The ratio measures your monthly income against your ongoing debts, including your mortgage, to estimate how large a payment you can afford on your budget.

DTI is calculated by adding up your monthly debt payments and dividing them by your gross (pre-tax) monthly income. This shows what percentage of your income is taken up by existing debts and how much of a mortgage payment you could afford on top of your current obligations.

While auto insurance is not included in the DTI ratio, homeowners' insurance is. This is because, if you have a mortgage, you must insure the house as the mortgage-giver wants the risk of loss insured. This insurance is mandatory, whereas auto insurance is not. If you run out of money, you could sell your car and drop the insurance to be able to continue paying your mortgage.

How to calculate your DTI ratio

Your debt-to-income (DTI) ratio is an important metric that lenders consider when assessing your eligibility for a loan. It is the percentage of your gross monthly income (before taxes) that goes towards payments for rent, mortgage, credit cards, or other debt.

Step 1: Calculate your gross monthly income

Your gross income is your total income before any deductions or taxes are taken out. This includes any pre-tax and non-taxable income that you want to be considered in the calculation.

Step 2: Calculate your total monthly debt payments

Add up all your monthly debt payments, including rent or mortgage, student loans, auto loans, credit card minimums, and any other regular payments. Also, include alimony, child support, or any other payment obligations that qualify as debt.

Do not include other monthly expenses such as utilities, groceries, insurance premiums, healthcare expenses, or daycare in this calculation.

Step 3: Divide your total monthly debt payments by your gross monthly income

Take your total monthly debt payments and divide it by your gross monthly income. This will give you a decimal number.

Step 4: Multiply the result by 100 to get the percentage

To express your DTI as a percentage, multiply the result from Step 3 by 100. For example, if your debt payments total $2,000 per month and your gross monthly income is $6,000, your calculation would be $2,000 / $6,000 x 100 = 33%.

A lower DTI ratio is generally more favourable to lenders as it indicates that you have a good balance between debt and income. While the ideal DTI ratio varies by lender and loan type, a DTI of 36% or lower is generally considered good.

It is important to note that DTI is just one factor that lenders consider when evaluating loan applications. Your credit history, credit score, and other financial metrics may also be taken into account.

What debts are included in the DTI ratio

The debt-to-income (DTI) ratio is a personal finance measure that compares an individual's monthly debt payments to their monthly gross income. It is calculated by dividing the total of an individual's monthly debt payments by their monthly gross income. The DTI ratio is expressed as a percentage and is used by lenders to determine an individual's borrowing risk. A low DTI ratio indicates that an individual has sufficient income relative to their debt servicing, while a high DTI ratio can signal that an individual has too much debt for their income.

The debts included in the DTI ratio calculation are those that are considered mandatory and typically include:

• Monthly rent or mortgage payments
• Alimony or child support payments
• Auto loans and other monthly loan payments (e.g. student loans)
• Credit card monthly payments (using the minimum payment)
• Personal loans
• Insurance premiums
• HOA fees

It is important to note that expenses such as groceries, utilities, gas, taxes, and healthcare expenses are generally not included in the DTI ratio calculation.

What payments should be excluded from the DTI ratio

When calculating your debt-to-income (DTI) ratio, it's important to know what payments to include and what to leave out. The DTI ratio is used by lenders to determine your borrowing risk and whether you can afford to take on more debt.

The following payments should be included in the DTI ratio:

• Monthly mortgage payments or rent
• Real estate taxes
• Homeowner's insurance
• Car payments
• Student loan payments
• Minimum monthly credit card payments
• Timeshare payments
• Personal loan payments
• Child support payments
• Alimony payments
• Co-signed loan payments

The following payments should be excluded from the DTI ratio:

• Monthly utilities (water, garbage, electricity, gas)
• Car insurance expenses
• Health insurance costs
• Groceries/food
• Entertainment expenses
• Transportation costs
• Savings account contributions
• 401(k) or IRA contributions
• Clothing costs

It's important to note that different lenders may have slightly different criteria for what is included and excluded from the DTI ratio. Therefore, it's always a good idea to check with your lender to ensure you are using the correct information when calculating your DTI ratio.

How DTI impacts your mortgage application

Lenders use the debt-to-income (DTI) ratio to assess your financial health and ability to manage monthly payments and debts. It is calculated by dividing your total monthly debt payments by your gross (pre-tax) monthly income.

Lenders typically look at two types of DTI ratios: front-end and back-end. The front-end ratio focuses on housing-related expenses, including property taxes, homeowners insurance, and any applicable homeowners association dues. While this number is less concerning for lenders, it can give you an idea of how much home you can afford.

The back-end ratio, which is the figure most lenders focus on, includes housing-related expenses and all other minimum monthly debt payments, such as credit cards, student loans, auto loans, and personal loans. This ratio gives lenders a more complete picture of your monthly spending.

A low DTI ratio indicates that you have a good balance between debt and income, making you a more attractive borrower. Generally, a DTI of 43% or less is preferred, with some lenders seeking ratios of no more than 36%. A DTI above 50% indicates a high level of debt, and lenders will likely deny mortgage applications with such a high ratio.

When applying for a mortgage, it is important to know your DTI ratio, as it is a key factor in getting approved for a loan. A high DTI may signal that you have too much debt relative to your income, making it challenging to secure a loan. Lenders assess your DTI to determine if you can comfortably afford monthly mortgage payments. Therefore, it is advisable to work on lowering your debt before applying for a mortgage if your DTI is high.

Frequently asked questions