Mortgage 101

What Is Debt-to-Income Ratio?

Published on: December 22, 2021

what is debt to income ratio

Your debt-to-income (DTI) ratio represents how much of your income goes toward debt repayment. During the mortgage approval process, lenders look at your DTI ratio to ensure you can afford the loan. Your mortgage debt-to-income ratio also helps determine how much you can borrow. 

Read on to learn more about what is debt-to-income ratio, including the role it plays in the lending decision and how to figure out your debt-to-income ratio.

What is debt-to-income ratio and why does it matter?

The debt-to-income ratio for buying a house or refinancing measures how much of a borrower’s income goes toward monthly debt payments.  

Lenders place a lot of weight on debt-to-income ratios for home loans because they shed light on whether or not a borrower can afford the mortgage along with their other financial obligations. A high DTI indicates a borrower may be over-committed, whereas a lower DTI suggests a borrower can comfortably afford the mortgage.

Debt-to-income calculation for mortgages

Not only does the mortgage debt-to-income ratio impact a borrower’s chances of approval, but it also plays a role in determining the loan amount. Generally, a borrower with a low DTI ratio will have more room for a higher loan payment.  

Loan programs have established maximum DTI ratios, and lenders will look to make sure the loan amount does not exceed the program limits. In the case of cash-out refinances, the mortgage-debt-to-income ratio will also help dictate how much equity a borrower can access.

How to calculate debt-to-income ratio using the DTI formula 

If you’re wondering how to figure out your debt-to-income ratio, you can use an income-debt ratio calculator or calculate it manually following the debt-to-income ratio formula:

Total monthly debt payments ÷ monthly gross income = DTI ratio 

Here’s how to calculate DTI in three simple steps:

3 steps to calculate DTI for mortgages 
Step 1  Add up the monthly payments on all of your debts. 

Include all credit cards, loans, court-ordered payments, and the projected mortgage payment. Do not include utility payments or other non-debt payments. When estimating your mortgage payment, make sure it includes principal, interest, taxes, and insurance (PITI). 

 

Step 2   Add up your gross monthly income. 

Include all sources of recurring monthly income; be sure to use the gross amount (before taxes and payroll deductions). 

 

Step 3  Divide your monthly payments by your monthly income. 

Once you’ve totaled your debt payments and income, divide your total monthly payments by your total monthly gross income.  

Debt-to-income ratio formula example 

Here’s an example of the debt-to-income ratio formula: If a borrower’s monthly payments, including the estimated mortgage payment totals $3,000, and their gross income is $7,500, then their DTI ratio is 40% ($3,000 ÷ $7,500 = 0.40 or 40%). 

What is my debt-to-income ratio? Front-end and back-end DTI

You may hear two terms related to the debt-to-income calculation for mortgages: front-end DTI and back-end DTI.

Here’s what they mean:

  • Front-end DTI: Your mortgage payment (including PITI) divided by your gross income. 
  • Back-end DTI: Your total monthly debt payments, including your new mortgage payment, divided by your gross income (this is also called total DTI). 

What is a good DTI ratio for buying a home?

Generally speaking, 36% or lower is a good DTI ratio (that’s back-end DTI, so include your total monthly debt payments when calculating yours). However, DTI ratios vary by loan type and lender. A standard maximum debt-to-income calculation for mortgages is 43%. This percentage represents the highest DTI ratio permitted for qualified mortgages (loans that meet specific guidelines and are considered safe for borrowers). As a result, many lenders look for a debt-to-income ratio of 43% or below. 

In some cases, lenders may allow a borrower’s DTI ratio to exceed established maximums. For example, the maximum DTI for some conventional loans is 36%; however, lenders can approve a buyer with a DTI ratio as high as 45% or more if other compensating factors are present, such as a higher credit score, cash reserves, or residual income (money left over after meeting financial obligations).

Some loan programs consider both the front-end and back-end DTI ratios. For instance, the max DTI for FHA loans is 31% for the front end and 43% for the back end. 

What is debt-to-income ratio by loan type? 

Here’s a look at established maximum DTI ratios for common loan types. Keep in mind your lender may permit a higher DTI or require a lower one. A local Finance of America Mortgage Advisor can help you learn the exact DTI requirements for the loan you’re considering.

Loan program  Maximum debt-to-income ratio 
Conventional  36%-50% 
FHA  31% front-end; 43% back-end (a higher DTI may be allowed in some cases) 
VA  41% (a higher DTI may be allowed based on residual income) 
USDA  29% front-end; 41% back-end 

How can I improve my debt-to-income ratio?

New changes to the rules for qualified mortgages place a lower emphasis on debt-to-income ratio for buying a house and a higher focus on other factors, such as interest rate and residual income. 

However, DTI ratios continue to play an essential role in the mortgage process. Taking steps to keep your DTI under your lender’s maximum will increase your chances of mortgage approval and stretch your borrowing power.  

Here are some ways to ensure you have a good DTI ratio:

  • Pay more than the minimum payments on your debts. Reducing the total amount you owe on each loan or credit card will reduce your total debt and lower your DTI ratio and make you more financially prepared to buy a home. You can pay more by freeing up room in your budget or transferring balances to lower-rate credit cards and paying the balances down faster. 
  • Avoid new credit or large purchases until after your mortgage approval. Additional loans and higher credit card balances will drive up your DTI ratio, so it’s best to wait until after you’ve secured a mortgage approval.  
  • Include all sources of income. Lenders consider all regularly occurring sources of income. So, if you have a second job, child support, or other sources of income, be sure to include them. This will lower your DTI ratio. 
  • Consider having a cosigner. Having a cosigner on the mortgage will increase the income used during the approval process. Keep in mind the lender will also count the cosigner’s debt, so be sure to calculate if this option will help you. 
  • Increase your income. A higher income will lower your DTI ratio, so it may be a good time to negotiate a salary increase or take on an additional job. 

To learn more about your home mortgage options, talk to a local Finance of America Mortgage Advisor today.

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