Debt-To-Income Ratio (DTI): What Is It And How Is It Calculated?
Mar 11, 2024
8-MINUTE READ
AUTHOR:
MIRANDA CRACEYour 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%.
DTI Requirements By Mortgage Type
The lower your DTI, the better. In most cases, you’ll need a DTI of 50% or less, but the specific DTI requirement will depend on the lender and the mortgage type.
FHA Loans
The Federal Housing Administration backs FHA loans. FHA loans have more lenient qualification requirements than other loans. Borrowers must have a minimum credit score of 580 to qualify for the loan.
The maximum DTI for FHA loans is 57%. However, a lender can set their own requirement. This means some lenders may stick to the maximum DTI of 57%, while others may set the limit closer to 40%. Do your research and speak with each lender you’re considering working with. They’ll tell you what ranges they accept.
USDA Loans
Borrowers can only use U.S. Department of Agriculture (USDA) loans to buy and refinance homes in eligible rural areas. Your DTI must be lower than 41% to qualify for a USDA loan.
USDA loans have a few unique requirements. First, you can’t get a USDA loan if your household income exceeds 115% of the median income for an area.
Second, your lender must consider the income of everyone in the household when evaluating your eligibility for a USDA loan. Lenders must verify income for everyone living in the home – even if they aren’t on the loan.
When determining whether your DTI qualifies you for a USDA loan, your lender will only factor in the income and debts of the borrowers on the loan. If other people live in the home, your lender will only consider their income to determine whether your household meets the loan’s income limits. It won’t factor into your DTI.
Please note that Rocket Mortgage® doesn’t offer USDA loans at this time.
VA Loans
VA loans are insured by the Department of Veterans Affairs. They offer a low-cost way for eligible current and former members of the armed forces and their surviving spouses to buy a home. VA loans don’t require a down payment and often have more lenient DTI requirements. You may be able to get a VA loan with a DTI of up to 60% in some cases.
Every lender will set their own requirements, though. Speak with your lender to learn what their requirements are.
Conventional Loans
There’s no single set of requirements for conventional loans. The DTI eligibility requirement typically depends on a borrower's finances, credit history and loan type. Generally, borrowers need a DTI of 50% or less to qualify for a conventional loan. If your DTI is high, you’ll need to offset your debt with high cash reserves to secure a loan.
How Can You Lower Your Debt-To-Income Ratio?
If your DTI is high, there are some strategies you can use to lower it before you apply for a mortgage.
Pay Off Your Smallest Debts
The fastest way to lower your debt-to-income ratio is to pay off debt. If you can afford it, pay off your smallest outstanding debt in full. This approach can impact your DTI relatively quickly. If you can’t afford to pay off your debt entirely, pay more than the minimum on your debts to pay them down faster, lowering your DTI over time.
Raise Your Income
To get a cash injection that lowers your DTI, take on a side hustle, pick up a few more hours at work or freelance. Keep in mind that this is not a quick fix. Your lender will require proof that the new income stream is steady and will continue. Lenders generally need to see at least 2 years of history for each source of income.`
Add Another Borrower To Your Loan
If you’re buying a home with your spouse or partner, your mortgage lender will calculate your DTI using both your income and debts. If your partner has a low DTI, you can lower your total household DTI by adding them to the loan.
However, if your partner’s DTI is similar to or higher than yours, adding them to the loan may not help your situation.
Add A Co-Signer To Your Mortgage
If you’re buying a house and your DTI is high, ask a family member or close friend if they’ll co-sign the mortgage loan. When you add a co-signer, lenders will factor in their DTI when reviewing your application, potentially helping you qualify for a larger mortgage or a lower interest rate.
Co-signers don’t have to live in the home with you. But they must agree to take over your mortgage payments if you default on the loan.
FAQs About Debt-To-Income Ratios
Here are a few frequently asked questions about DTI to help you prepare for the application process.
Is all debt treated the same in my debt-to-income ratio?
Ultimately, your total recurring debt influences your debt-to-income ratio and can improve or lower your chances of getting qualified for a mortgage. The ratio doesn’t weigh the type of debt differently. The more debt you have, the higher your DTI and the harder it may be to qualify for a great loan.
How quickly can I improve my DTI?
The fastest way to improve your DTI ratio is by paying down your debt. The more aggressively you pay it down, the more you’ll improve your ratio and chances of mortgage approval. You can also improve your DTI by growing your income with a side hustle or negotiating a raise at work.
Should I apply for a home loan with a high DTI?
While you can have a high DTI and qualify for a mortgage loan, it’s best to look for ways to reduce it. Lenders are typically less willing to approve mortgage loans for borrowers with high debt-to-income ratios. If a borrower qualifies for the loan, the lender may ask them to pay a higher interest rate. Lowering your DTI before applying can help you get a better interest rate.
Does my DTI influence my credit score?
Your debt-to-income ratio doesn’t influence your credit score. DTI is a formula that allows you to see how much of your gross monthly income goes toward repaying your fixed monthly debt. A high DTI doesn’t necessarily mean your credit score is low, provided you make your minimum payments on time.
The Bottom Line
Your debt-to-income ratio is a key factor when it comes to qualifying for a mortgage. It reflects the percentage of your gross monthly income allocated to paying off your recurring debt. Your DTI ratio helps lenders gauge how much mortgage you can comfortably afford.
A DTI of 43% or less can offer the most options when applying for a mortgage. Start an application today and see what options you’re eligible for. You can also give us a call at (833) 326-6018.
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