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

When you apply for a mortgage, the lender looks at your debt-to-income ratio (DTI). This figure compares how much money you owe (your debts) to how much money you earn (your income). Before applying for a home loan, it’s just as important to know your DTI ratio as it is to check your credit score. You should also know what percentage lenders typically look for to help increase your approval odds.

What is a debt-to-income ratio?

Expressed as a percentage, your debt-to-income ratio is the portion of your gross (pre-tax) monthly income spent on repaying regularly occurring debts, including mortgage payments, rents, outstanding credit card balances and other loans. It’s a comparison of what’s going out each month vs. what’s coming in.

Types of DTI ratios

Lenders typically focus on two kinds of DTI ratios.

• Front-end ratio: Also called the housing ratio or mortgage-to-income ratio, this shows what percentage of your income would go toward housing expenses. It includes your monthly mortgage payment (principal and interest), 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 loans, child support, and student loans — the predictable, regularly recurring items. Living expenses, such as utilities, are not included, however.

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 ratio 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 loan and monthly payment you can afford.

Having a lower DTI ratio doesn’t just make it easier to get approved for a mortgage. It can also help you get a better interest rate, and, as a result, save you money over the life of your loan.

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

Lenders assess your DTI ratio to determine if you can comfortably afford to make monthly mortgage payments. A solid credit score, stable earnings and exceptional payment history are important. But if your monthly debt repayments already eat up a lot of your income, a mortgage lender might consider you too much of a risk to extend financing to.

How to calculate your debt-to-income ratio

You can calculate your DTI ratio before applying for a mortgage, regardless of which kind of loan you want.

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 ratio 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 toward your car loan, $150 toward 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:

1,800 ➗ 6,000 x 100 = 30%

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:

$2,650 ➗ 6,000 x 100 = 44%

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 their 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 ratio 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 terms of DTI for mortgage applications. In a real-life scenario, 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

To some extent, the type of mortgage you want affects the DTI parameters. The range isn’t huge, and a lot is at the individual lender’s discretion, but different loans tend to have different thresholds.

How to lower your debt-to-income ratio

If your debt-to-income ratio for a mortgage is not within the recommended range, you can aim to lower it. If money’s tight, you may be best off making a smaller down payment and applying your savings to those bills, says Adam Schick, account supervisor at The Wilbert Group.

“Even with a slightly higher mortgage due to a larger loan amount (and potentially higher mortgage insurance), the potential offsetting benefit of paying off the consumer debt can open up a customer’s debt-to-income ratio,” says Schick.

Here are some ways to get a good debt-to-income ratio:

• Pay off debt: If possible, the preferred option to lower your DTI ratio is to repay as much of your debt as you can manage. To make the most impact, prioritize the bill with the highest monthly payment.
• Refinance existing loans: Seek out options for lowering the interest rate on your debt or attempt to lengthen the loan’s duration.
• Pay off high-interest loans: Focus on repaying the more expensive 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 additional income: If you’re able to earn more, it will help improve your DTI ratio.
• Look into loan forgiveness: These types of programs may help to eliminate some of your debt entirely.

How quickly can I improve my DTI ratio?

If you can boost your income or have cash reserves that you can use to pay off debt, you could improve your DTI ratio quickly. 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.

FAQ

• Can I get a mortgage with a high DTI?

  It can be possible to get a mortgage, even without a good debt-to-income ratio. 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 show a strong credit history and financial reserves. Being able to make a large down payment helps, too.

• 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 your credit utilization ratio (how close to your credit card limits your balances are). If you improve your DTI by paying off various obligations, it will help improve your credit score, too.

• What are the limitations of the debt-to-income ratio?

  When applying for a mortgage, the debt-to-income ratio is certainly important, but it’s just one of many factors that lenders consider when reviewing your mortgage application. They’ll also look at your credit score, employment record and down payment size. Also, your DTI ratio weighs all types of debt equally — whether they’re low or high interest – so your ratio will be higher the more debt you have.

Additional reporting by Meaghan Hunt