When you apply for a mortgage, a lender considers your debt-to-income ratio as a critical measuring stick. You could have a good credit score, stable earnings and pay all your bills on time, but if monthly debt payments eat up too much of your income, a lender will take that into account when determining your ability to take on a mortgage.
That’s why it’s just as important to know your debt-to-income ratio, or DTI, as it is to check your credit score before applying for a mortgage.
How to calculate debt-to-income ratio
First, there are two types of ratios lenders evaluate:
- 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 and homeowners association fees, if applicable.
- Back-end ratio: This shows how much of your income would be needed to cover all monthly debt obligations. This includes the mortgage and other housing expenses, plus credit cards, auto loan, child support, student loans and other debts. Living expenses, such as utilities and groceries, are not included in this ratio.
The back-end ratio may be referred to as the debt-to-income ratio, but both ratios are usually factored in when a lender says they’re considering a borrower’s DTI.
Debt-to-income ratio example
To calculate your front-end ratio, add up your monthly housing expenses and divide it by your gross monthly income, then multiply the result by 100. For instance, if all your housing-related expenses total $1,800 and your gross monthly income is $6,000, your DTI is 30 percent.
To determine the back-end ratio, add up all your monthly debt payments, including your housing expenses, and divide the result by your monthly gross income.
Let’s say you have a car loan that is $500 per month, you pay $150 per month in student loans and $200 per month toward credit card bills. That adds up to $850.
Combine that with your $1,800 in monthly housing expenses and you get $2,650 in total monthly debts. Based on your monthly income of $6,000, your back-end ratio would be 44 percent.
Ideal debt-to-income ratio for a mortgage
Lenders generally look for the ideal front-end ratio to be no more than 28 percent, and the back-end ratio, including all monthly debts, to be no higher than 36 percent.
So, with $6,000 in gross monthly income, your maximum amount for monthly mortgage payments at 28 percent would be $1,680 ($6,000 x 0.28 = $1,680). Your maximum for all debt payments, at 36 percent, should come to no more than $2,160 per month ($6,000 x 0.36 = $2,160).
In reality, however, depending on your credit score, how much you have in savings and the size of your down payment, lenders may accept higher ratios. Limits vary depending on the lender and the type of loan.
For conventional loans, most lenders focus on your back-end ratio. Although not written in stone, most conventional loans require 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.
For FHA loans, the recommended front-end ratio is 31 percent and recommended back-end ratio is 43 percent — but as with conventional loans, there are exceptions that bump the cap higher.
How to lower your DTI
If your DTI is not within the recommended range, you can attempt to lower your DTI through a number of techniques. The preferred option is to pay off as much of your debt as you can manage, but you can also try restructuring your loans. Seek out options for lowering the interest rate on your debt or attempt to lengthen the duration of the loan through refinancing options. Look into loan forgiveness programs that may help to eliminate some of your debt entirely.
If you’re unable to refinance your loans, focus on paying off the high-interest ones first. These carry a heavier weight in your DTI calculation, so paying them off first will improve the ratio.
If you can, seek out an additional source of income. This additional stream of income will help to improve your DTI ratio.
How to get around a high DTI
The easiest way to lower your debt-to-income ratio is to pay off as much debt as you can — but many borrowers don’t have the money to do that when they’re in the process of getting a mortgage, because much of their savings are tied up in a down payment and closing costs.
If you think you can afford the mortgage you want but your DTI is above the limit, a co-signer might help solve your problem. Unlike with conventional loans, borrowers can have a relative co-sign an FHA loan and the co-signer won’t be required to live in the house with the borrower. The co-signer does need to show sufficient income and good credit, as with any other type of loan.
Sometimes, though, a co-signer isn’t the answer. If your DTI is too high, for example, you should consider focusing on improving your financial situation before committing to a mortgage.
The bottom line
Your debt-to-income ratio is an important metric for lenders when considering your mortgage. However, there are paths to getting a mortgage with a high DTI by refinancing or getting a co-signer.