What is a debt-to-income ratio for a mortgage?

When you apply for a mortgage, there’s a key figure that a lender looks at: your debt-to-income ratio (DTI). Your DTI compares how much money you owe (your debts) to how much money you earn (your income). Your regular outgoing vs incoming, in other words, encapsulated in a percentage figure.

Before applying for a home loan, it’s just as important to know your DTI ratio as it is to check your credit score. Here’s why — and how to figure out what is a good debt-to-income ratio if getting a mortgage is your goal.

Why does your debt-to-income ratio matter to lenders?

Why do lenders care about your DTI? Basically, because it helps them determine whether you’re financially secure enough to add mortgage payments to your current obligations. You could have a good credit score, stable earnings and a great bill-paying record, but if monthly debt repayments already eat up a major portion of your income, a lender might consider you too much of a risk to extend a home loan to.

Actually, there are two types of DTI ratios that lenders look at:

• Front-end ratio: Also called the housing ratio, this shows what percentage of your income would go toward housing expenses. This includes your monthly mortgage payment, property taxes, homeowners insurance premiums and homeowners association fees, if applicable.
• Back-end ratio: This shows how much of your income goes to cover all monthly debt obligations. This includes the mortgage (if you get it) and other housing expenses, plus credit cards, auto loan, child support, student loans — the predictable, regularly recurring items. Living expenses, such as utilities, are not included, however.

Mortgage lenders might hesitate to work with borrowers with high DTI ratios because there’s a larger risk that they might not be able to repay their loan — given all the other significant demands on their purse. They don’t want you getting in over your head, in other words.

What is a good debt-to-income ratio?

For conventional loans, most lenders focus on your back-end ratio — the overall tally of your debts vis-à-vis your income. Most conventional loans allow for a DTI of no more than 45 percent, but some lenders will accept ratios as high as 50 percent if the borrower has compensating factors, such as a savings account with a balance equal to six months’ worth of housing expenses.

It probably goes without saying: Lower is better. Lenders generally look for the ideal candidate’s front-end ratio to be no more than 28 percent, and the back-end ratio to be no higher than 36 percent. They then work backward to figure out how much of a mortgage and a mortgage payment you could afford.

How to calculate debt-to-income ratio

You can calculate your DTI ratio before you apply for a mortgage, regardless of which kind of loan you’re looking to get.

Follow these steps to calculate your back-end DTI:

1. Add up your monthly debt payments: Factor in all of your debt obligations, including rent and house payments, personal loans, auto loans, child support or alimony, student loans and credit card payments. If you’re applying with someone else, combine both of your monthly debts. Don’t include other monthly expenses like food and utilities.
2. Divide your debts by your monthly gross income: Next, divide your debt payments by your pre-tax monthly income. Again, make sure you’re using the combined debts and income of all mortgage applicants.
3. Convert the figure into a percentage: The final step is to convert your DTI from a decimal to a percentage, by multiplying it by 100.

Debt-to-income ratio examples

Let’s say your monthly gross income is $6,000. Your monthly rent comes to $1,800. Each month you pay $500 towards your car loan, $150 towards your student loans and $200 toward credit card bills. That adds up to $850.

To calculate your front-end ratio, add up your monthly housing expenses only, divide that by your gross monthly income, then multiply the result by 100. It would come to 30 percent:

To determine the back-end ratio, add up all your monthly debt payments (the rent, the loans and the credit cards) — that would come to $2,650. Then  divide the result by your monthly gross income and convert it into a percentage. It would come to 44 percent:

Calculating the ideal DTI

Let’s do as the lenders do, and work backward to see what would make you a good loan candidate in a lender’s eyes, using our earlier income and debt examples above.

If you’ve got $6,000 in gross monthly income, to have that desired front-end DTI be 28 percent, your maximum monthly mortgage payment would be $1,680 ($6,000 x 0.28 = $1,680). For the 36 percent back-end ratio, your maximum for all debt payments should come to no more than $2,160 per month ($6,000 x 0.36 = $2,160).

These would be the ideal figures. In a real-life application, lenders may accept higher ratios. It depends on your credit score, your savings/liquid assets, and the size of your down payment.

Debt-to-income ratio requirements by loan type

DTI limits vary depending on the lender and the type of loan. While much is at individual lender’s discretion, certain kinds of loans tend to have similar thresholds.

• Conventional loan: Typically 28% for front-end; for back-end, 36%, up to 45%-50% for otherwise well-qualified borrowers
• FHA loan: Typically 31% front-end; back-end 43%, up to 57% with exceptions
• VA loan: no set limits; 41% recommended for back-end
• USDA loan: Typically 29% for front-end; for back-end, 41%, up to 44% with exceptions

How to lower your debt-to-income ratio

If your debt-to-income ratio is not within the recommended range, you can aim to lower your DTI. Here are some ways:

• Pay off debt: If possible, the preferred option to lower your DTI is by repaying as much of your debt as you can manage. To make the most impact, prioritize the debt with the highest monthly payment.
• Refinance existing loans: Seek out options for lowering the interest rate on your debt or attempt to lengthen the duration of the loan.
• Look into loan forgiveness: These types of programs may help to eliminate some of your debt entirely.
• Pay off high-interest loans: If you’re unable to refinance your loans, focus on repaying the higher-interest ones first. These carry a heavier weight in your DTI calculation, so paying them off first will improve the ratio.
• Get a co-signer: If someone who shows sufficient income and good credit — better than yours, preferably — is willing to sign onto the loan with you, it’ll boost your candidacy.  With conventional loans, the co-signer often has to reside in the house. FHA loans don’t carry that requirement.
• Seek out an additional income: Attack the problem from the opposite end. If you’re able to earn more, it will help improve your DTI ratio.

Bottom line on DTIs and mortgages

Your debt-to-income ratio is an important metric for lenders when considering your application. Not only does it give them insight into your current financial health, it helps them determine if you can handle a mortgage in addition to your other obligations.

The best DTI is the lowest DTI. However, even if yours is on the high side, you may still be able to get a mortgage by refinancing your loans, getting a co-signer or repaying your high-interest loans before lower-interest ones.

DTI FAQs

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  How quickly can I improve my DTI?

  How quickly you can improve your DTI varies significantly. If you can quickly boost your income or have cash reserves that you can use to pay off debt, you could change your DTI in a day.Realistically, if you’re saving for a home, you can’t afford to put all your savings toward paying off existing debt, so you’ll want to take a slow, steady approach over weeks or months. Bear in mind it’ll probably take at least a month or two for the change to be reflected in your credit history and a billing cycle or two for a significant change to register on your credit score.
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  Can I get a mortgage with high DTI?

  It can be possible to get a mortgage, even with a high DTI. However, it will depend on the type of loan you’re applying for and how high your DTI is. FHA loans and VA loans allow for the highest DTI ratios— provided those applicants exhibit a strong credit history and financial reserves. Being able to make large down payments helps too.
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  Does DTI impact my credit score?

  Your debt-to-income ratio doesn’t directly shape your credit score because your credit report does not include information about your income. However, your total amount of debt does play a role in determining your credit score, especially in terms of how close to your credit card limits they are. If you improved your DTI by paying off various obligations, it will help improve your credit score too.

Additional reporting by T.J. Porter