When you apply for a mortgage, a lender considers your debt-to-income ratio, or DTI, as a critical evaluation point.
Your DTI lets lenders know how much debt you have compared to your income, which helps them determine whether you’re financially secure enough to add a mortgage to your monthly debt payments. You could have a good credit score, stable earnings and pay your bills on time, but if monthly debt payments eat up too much of your income, a lender might consider you too much of a risk to take on a mortgage.
That’s why it’s just as important to know your DTI ratio as it is to check your credit score before applying for a mortgage.
What is the debt-to-income ratio?
Expressed as a percentage, your debt-to-income ratio for a mortgage is the portion of your gross monthly income (pre-tax) spent on repaying debts, including mortgage payments or rent, credit card debt and auto loans.
Lenders might hesitate to work with someone who has a higher DTI ratio because there’s a larger risk that the borrower might not repay their loan if they have other significant debt payments.
How to calculate debt-to-income ratio
There are two types of ratios that 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 debt-to-income ratio for a mortgage.
Follow these steps to calculate your DTI:
- Add 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 all of your monthly debts. Don’t include other monthly expenses like food and utilities.
- 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.
- Convert the figure into a percentage: The final step is to convert your DTI from a decimal to a percentage.
Debt-to-income ratio example
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. For instance, if all of your housing-related expenses total $1,800 and your gross monthly income is $6,000, your front-end ratio is 30 percent.
To determine the back-end ratio, add up all your monthly debt payments, including your housing expenses, divide the result by your monthly gross income and convert it into a percentage.
Let’s say each month you pay $500 for a car loan, $150 for student loans and $200 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 about 44 percent.
Ideal debt-to-income ratio for a mortgage
For conventional loans, most lenders focus on your back-end ratio. 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.
Although certain lenders will accept DTIs up to 50 percent, lower is better. In terms of your front-end and back-end ratios, 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 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 may increase the cap.
If you’re applying for a USDA loan, your front-end ratio should be under 29 percent and your back-end ratio should be below 41 percent.
For VA loans, there is no set maximum DTI. However, it’s ideal to aim for a back-end ratio of less than 41 percent. If your ratio is higher than that, you could still be approved depending on other factors.
How to lower your DTI
If your debt-to-income ratio is not within the recommended range, you can lower your DTI a number of 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.
- Restructure 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: 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.
- Seek out an additional source of income: If you’re able to, generating an additional income stream will help 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.
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 situation; it helps them determine if you can handle a mortgage in addition to your existing debt.
However, even if you have a high DTI, 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.