Debt-To-Income Ratio (DTI): What Is It And How Is It Calculated?
Author:
Miranda CraceMar 11, 2024
•8-minute read
Your debt-to-income ratio (DTI) is an important part of how mortgage lenders evaluate your financial health. DTI ratios represent how much debt you have compared to your income.
It’s important to know your DTI as you consider buying a home. If you have a high amount of debt compared to income, consider `lowering your debt before applying for a loan. Even if you’re prepared to apply for a loan, you may struggle to find a lender willing to work with a high DTI.
Let’s look at DTI, how it works and how it impacts your mortgage application so you can prepare to start shopping for homes.
What Is Debt-To-Income Ratio?
Your debt-to-income ratio, or DTI, is a percentage that tells lenders how much money you spend on monthly debt payments versus how much money you have coming into your household. You can calculate your DTI by adding your monthly minimum debt payments and dividing the total by your monthly pretax income.
The result can give you an idea of where your finances stand and how much home you can realistically afford.
Your lender may look at two types of DTI during the mortgage process: front-end and back-end DTI.
Front-End DTI
Front-end DTI only focuses on housing-related expenses. It’s calculated using your current monthly mortgage or rent payment, including property taxes, homeowners insurance and any applicable homeowners association dues.
Lenders typically won’t worry about this number when reviewing your mortgage application, except for some exceptions, such as Federal Housing Administration (FHA) loans. However, the result can give you an idea of where your finances stand and how much home you can realistically afford.
Back-End DTI
Back-end DTI includes your housing-related expenses and all the minimum required monthly debt payments your lender finds on your credit report, including credit cards, student loans, auto loans and personal loans.
Your back-end DTI is the number most lenders focus on because it gives them a more complete picture of your monthly spending.
Why Is Your DTI Ratio Important?
Your DTI offers lenders a better understanding of your overall financial health. The ratio shows how much debt you have relative to your monthly income. It helps lenders assess your ability to cover the cost of a monthly mortgage on top of any existing debt.
What Is A Good Debt-To-Income Ratio?
Most lenders will accept a DTI ratio of 43% or less. However, it’s helpful to understand how different ranges can impact your chances of approval when applying for a mortgage.
Let’s look at typical DTI ranges and how they can impact mortgage qualification:
- DTI below 36%: A DTI ratio below 36% demonstrates to lenders that you have a manageable level of debt. You shouldn’t have trouble qualifying for a loan or line of credit.
- DTI from 36% to 41%: A DTI ratio in this range indicates to lenders that you have a manageable level of debt and earn enough income to cover a new mortgage payment. Lenders are more likely to approve loans for borrowers with DTIs in this range.
- DTI from 43% to 50%: A DTI ratio in this range often signals to lenders that you have a lot of debt and may struggle to repay a mortgage.
- DTI over 50%: A DTI ratio of 50% or higher indicates a high level of debt and signals that the borrower is probably not financially ready to repay a mortgage. Lenders typically deny borrower applications when the DTI ratio is this high.
Figuring out your DTI can help you decide if now is the time to buy a home. If your DTI ratio is high, waiting may be a better option. However, if your ratio is low, you can take advantage of your proven ability to manage debt and apply for a home loan.
How To Calculate Debt-To-Income Ratio
Calculating your debt-to-income ratio is essential to understanding where you’ll stand with lenders before applying. Here’s how to calculate your DTI ratio in a few short steps.
1. Add Up Your Minimum Monthly Payments
To calculate DTI, include your regular, required and recurring monthly payments. Only use your minimum payments – not the account balance or the amount you typically pay. For example, if you have a $10,000 student loan with a $200 minimum monthly payment, you should only include the $200 minimum payment when calculating DTI.
Expenses To Include In Your DTI Calculations
Here are some examples of applicable debt when applying for a mortgage:
- Your rent or monthly mortgage payment
- Any monthly homeowners association (HOA) fees
- Property taxes
- Homeowners insurance payments
- Auto loan payments
- Student loan payments
- Child support or alimony payments
- Credit card payments
- Personal loan payments
Expenses To Exclude From Your DTI Calculations
Certain expenses should be left out of your minimum monthly payment calculation, including the following:
- Utility costs
- Health insurance premiums
- Transportation costs
- Savings account contributions
- 401(k) or IRA contributions
- Entertainment, food and clothing costs
Total Monthly Payments Example
Here’s an example of calculating your total monthly payments to determine your DTI. Imagine you have the following monthly expenses:
- Rent: $500
- Student loan minimum payment: $125
- Credit card minimum payment: $100
- Auto loan minimum payment: $175
Add $500, $125, $100 and $175 together, and the total is $900 in minimum monthly payments.
2. Divide Your Monthly Payments By Your Gross Monthly Income
Your gross monthly income is the total pretax income you earn each month. If another borrower is applying with you, you should factor in their income and debts, too.
Once you’ve determined the total gross monthly income for everyone on the loan, divide the total of minimum monthly payments by the gross monthly income.
3. Convert Your Result To A Percentage
Your initial result will be a decimal. To express your DTI ratio as a percentage, multiply the result by 100. In this example, your gross monthly income is $3,000, and your minimum monthly payment total is $900. When you divide $900 by $3,000, you’ll get 0.30. Multiply 0.30 by 100 to get 30, making your DTI ratio 30%.
You’d likely meet a lender’s DTI requirement because the DTI ratio falls below 43%.