Real Estate Tips |8 min read

Debt-to-Income Ratio for an Investment Property: Easy Guide

Last updated August 13, 2024

The DTI, or debt-to-income ratio for an investment property, plays a huge role in how likely lenders will approve you for real estate investor loans. It’s an essential part of the lending application process, so let’s break down this calculation, step-by-step.

Main Takeaways

A debt-to-income (DTI) ratio calculates how much of your income is taken up by debt and home-living expenses. By extension, it indicates how much wiggle room you would have to add another loan to detract from your income.
The lower your DTI score, the less of your income goes towards debt and other expenses. As a result, you have more funds left over to consistently pay for a new loan.
Lenders love scores under 36%, cautiously like scores under 43%, and may be hesitant to borrow from people with scores above that.

What Is the Debt-to-Income Ratio for an Investment Property?
How to Understand This Calculation
How To Calculate Your DTI Ratio for an Investment Property
An Example
How Can You Lower Your Debt-to-Income Ratio for an Investment Property?

What Is the Debt-to-Income Ratio for an Investment Property?

Your DTI, or debt-to-income ratio for an investment property, is a calculation that quantifies how much of your income you spend on specific expenses, which we’ll get into soon below. This ratio indicates whether your income is high enough to tackle your overall dues and afford real estate investor loans on top of that.

In other words, the DTI for an investment property divides the difference between your total monthly dues and your total pretax income. Then, you create a percentage for your loan from this result.

The percentage reflects how much of your income is being taken up by current expenses—or, in other words, the amount of income you don’t have to spare on real estate investor loans, such as Baltimore hard money loans.

As an aside, rest assured that your debt-to-income ratio for an investment property does not impact your credit score.

Back-End DTI

In terms of common real estate lingo, Back-End DTI is what most people think of when they hear the word “DTI.” In essence, a back-end DTI for an investment property compares the costs of any potential real estate investor loans to any home-occupation costs and outstanding debts you may have. This could include student debt, credit card bills, and more.

Front-End DTI

Less utilized is the front-end DTI for an investment property. A front-end DTI calculates how your debt compares to basic home-living expenses, like the rent or property taxes. Of course, this refers to the home you live in, not any other residential properties you may own.

Most lenders don’t put much stock into this calculation. After all, it doesn’t tell them the full story of your financials. However, you may still want to calculate it for your own sake. This can let you know if a new debt would jeopardize your very ability to have a roof over your head, should the chips be down.

How to Understand This Calculation

The lower your DTI ratio percentage is, the more able you can afford your monthly debt payments. On the other hand, the higher your DTI ratio percentage is, the less likely you will be able to juggle debt payments and life expenses. Due to this, your DTI ratio for an investment property will affect how likely a lender will accept your application.

For instance, it’s reassuring to lenders if you generate a 20% percentage rate. That means you will only shave off 20% of your earnings on debt payments, leaving you lots of wiggle room to afford this expense, even if life brings surprises in store. However, if your DTI ratio stands at a staggering 70%, that means you could struggle to dish out payments every month. No lender wants that.

Each lender has their own DTI ratio limits. However, as a rule of thumb, most lenders will turn away applicants with DTI ratios that rise up to the mid-40s range.

As a general guideline, applicants with DTI ratios under 36% will more likely get the green light. Applicants whose DTI ratios are up to 42% will get a yellow light—some lenders may pass, while other lenders may proceed with caution. Meanwhile, any higher than that, and most lenders may give you the red light and refuse your real estate investor loans.

How To Calculate Your DTI Ratio for an Investment Property

You can find your back-end DTI ratio for an investment property with this formula:

All monthly home-occupation expenses and all monthly debt payments ÷ your pre-tax monthly income = DTI ratio (expressed as a decimal)
Result x 100 = Your DTI ratio (converted into a percentage)

Optionally, you can calculate your front-end DTI ratio for an investment property with this formula:

All monthly home-occupation expenses ÷ your pre-tax monthly income = DTI ratio (expressed as a decimal)
Result x 100 = Your DTI ratio (converted into a percentage)

Some monthly debt payments you can include are:

Student loans
Credit card payments (only count your minimum payments)
Auto loans
Personal loans
Court-ordered payments, like child support

Also, some residential expenses you could consider are:

Rent or mortgage
Property-related taxes
Home-related insurance, like rental insurance, homeowner’s insurance, appliance insurance, etc.
Appliance rental or pay-in-installment fees

In addition, here are a few income sources you may want to put in your calculations, without taxes factored in:

Your monthly paycheck (part-time, full-time, per-diem, etc)
Real estate investing income
Income from stock trading
Court-ordered payments, like child support

A few expenses you shouldn’t factor in are:

Utility costs
Savings account additions
Food
Public transportation fees, gas, or other transportation expenses
Disposable income-related expenses (like going to the movies)
Health insurance

An Example

Now, let’s break down what a full, back-end debt-to-income ratio for an investment property would look like. Essentially, we want to fill out the formula we shared earlier:

All monthly home-occupation expenses and all monthly debt payments ÷ your pre-tax monthly income = DTI ratio (expressed as a decimal)
Result x 100 = Your DTI ratio (converted into a percentage)

First, let’s calculate “all monthly home-occupation expenses and monthly debt payments.” Imagine that, as a very simple example, it looks like this for you:

$1,000 – rent

$300 – auto loan debt

$500 – minimum credit card payment

Overall, you’d owe $1,800 per month in DTI-relevant expenses.

Second, let’s get into the “pre-tax monthly income” part of the formula. Let’s say that you’re an assistant to the regional manager at a local paper company. Furthermore, you own a beet farm and run a Bed and Breakfast there. These bring you multiple streams of income:

$3,000 – monthly paycheck

$1,000 – Bed and Breakfast income

$2,500 – Beet Farm income

Put together, you make $6,500 in income per month.

Third, we’ll divide your expenses and income:

$1,800/$6,500 = 0.28

Fourth, we’ll multiply that by 100 to get the percentage.

0.28 x 100 = 28%

All in all, your debt-to-income ratio for an investment property would be 28%. You’d be a prime applicant for real estate investor loans.

How Can You Lower Your Debt-to-Income Ratio for an Investment Property?

If your DTI is high, you need to address the core, root issue that makes it high in the first place: your debt. This way, you can get and benefit from real estate investing loans. There are a few ways to go about this:

Pay Off More than Your Debt Minimum: This almost sounds too straightforward, but at the end of the day, it’s one of the biggest ultimate solutions you have. Even if you can’t pay it all off, simply removing the biggest amount possible will help. Every dollar helps you chip at your DTI rate more.
Get Extra Work: If possible, it might be helpful to pick up a side job, whether it’s just a small, 1099 contracting role, a part-time gig, or extra hours at your full-time job.
Consolidate Your Debt: Consolidating your debt could provide you with more manageable monthly payments. As a result, you could reduce your debt per month and improve your DTI.
Add a Co-Signer: A co-signer with a better DTI ratio, such as a partner or family member, could boost your chances of approval for real estate investor loans. After all, your lender will add the co-signer’s ratio to yours, which could improve yours.

Get Real Estate Investor Loans with MHML

The debt-to-income ratio for an investment property can help you gauge whether you’re ready to benefit from a new real estate investing loan, such as a hard money loan.

Hard money real estate investing loans can be a great way for you to fund your new property. As we covered before, you can receive them and pay them off much more quickly than you would traditional real estate investing loans. Even better, when you get loans from us, you also gain a connection with extensive experience in the real estate industry. After all, we aren’t just your lender in your business dealings. We’re also your partner in this industry. Call us today to increase your financial and social capital.