Debt-to-income ratio (DTI): What is it and how is it calculated?

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. 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.

Because front-end DTI only considers housing costs, these costs are included in the calculation:

• Mortgage or rent payment
• Property taxes
• Homeowners or renters insurance
• HOA fees

Back-end DTI

Your back-end DTI is the number most lenders focus on, because it gives them a more complete picture of your monthly spending. It includes all of your monthly debt obligations, including:

• Credit card payments
• Student loan payments
• Car notes
• Personal loan payments
• Child support payments

Keep in mind that DTI only looks at debt obligations, not other recurring monthly bills. The following are not typically included in DTI ratio calculations because they are not debt payments:

• Utility costs
• Health insurance premiums
• Transportation costs
• Savings account contributions
• 401(k) or IRA contributions
• Entertainment, food, and clothing costs

Why your DTI ratio matters

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?

In general, the lower your DTI ratio, the better it looks to lenders. For many loans, the maximum  DTI ratio is 43%. Still, 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 may deny borrower applications when the DTI ratio is this high.

How to calculate debt-to-income ratio

One good thing to do before applying for a loan is to calculate your own DTI ratio. This will give you an idea of how lenders will perceive your application and give you the opportunity to lower your DTI ratio before applying.

The formula for calculating your DTI ratio is:

Monthly debt payments / monthly pre-tax income = DTI ratio

For example, imagine that you make $6,000 per month and have the following monthly debt payments:

• $400 student loan
• $450 car loan
• $250 credit card
• $100 personal loan

Your DTI ratio would be:

($400 + $450 + $250 + $100 ) / $6,000

$1,200 / $6,000 = 20%

FAQ

Your DTI ratio is one factor that impacts your ability to get a loan. Understanding how it influences your chances of approval and how to improve your DTI ratio can help you qualify for a mortgage.

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 your DTI before applying. 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 does not directly influence your credit score. Though your total amount of debt can affect your credit score, your income doesn’t.

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: The lower your DTI, the better

 Your debt-to-income ratio (DTI) gives lenders a quick way to understand how much of your income you’re putting toward your debt payments. The lower your DTI ratio, the better you’ll be able to handle payments on your new mortgage, making you a more appealing borrower. Taking steps to reduce your DTI ratio before applying for a mortgage can make it easier for you to qualify and help you secure a lower interest rate.

If you’re ready to apply for a mortgage, you can see what you may qualify for by contacting Rocket Mortgage^®.