To get a home loan, borrowers must meet certain eligibility requirements that show lenders they can afford the property and subsequent monthly mortgage payments. One factor is a borrower’s debt-to-income (DTI) ratio. It’s an important calculation that shows a lender how much of a borrower’s income is accounted for by existing debts.
Your DTI ratio must stay below a certain limit, regardless of your income level, or lenders may view your debt as too high for loan approval.
What Is a Debt-to-Income Ratio?
A debt-to-income ratio is a percentage that measures a potential homebuyer’s debt against their current income. It’s an important signal to lenders since what you can afford doesn’t always hinge on how much you make — it’s more about how much of your earnings you still have available to spend on something like a home.
What Does DTI Include?
- Monthly housing costs: Including your rent or mortgage principal and interest. If you own your home, you should also include property taxes and your homeowners insurance premium. If you pay HOA fees or private mortgage insurance (PMI), those should also be factored in.
- Monthly debt payments: Your DTI ratio only considers the minimum payment requirements for outstanding debts on car loans, credit cards, personal loans and student loans. The cost of obligations such as alimony and child support are also part of the calculation.
- Gross monthly income: This includes your salary and hourly wages, as well as commissions, tips and bonuses. Any additional income, like a pension, social security, child support or alimony, should be included in your gross income.
What’s Excluded From DTI?
Your debt-to-income ratio does not account for the cost of expenses like your car insurance, cable and cell phone bills, or health insurance. It also excludes food and entertainment expenses, as well as utility bills for electricity, gas, garbage and water.
How to Calculate Your Debt-to-Income Ratio
To calculate your debt-to-income ratio, divide your total monthly debt by your total gross monthly income, then multiply the result by 100.
(Total Monthly Debt ÷ Total Gross Monthly Income) X 100 = DTI Ratio
Debt-to-Income Ratio Example
Here’s an example of what a DTI ratio might look like with an $84,000 salary and debts that include an auto loan, credit card payments and a mortgage:
- Auto loan payment: $600
- Minimum credit card payment: $400
- Mortgage payment: $1,400
- Gross monthly income: $7,000
The total monthly debt in this example is $2,400: $600 + $400 + $1,500 = $2,400
The debt-to-income ratio is 34%: ($2,400 ÷ $7,000) X 100 = 34%
Why Does Your DTI Ratio Matter as a Homebuyer?
No matter how much you earn, if too much of your income is already spoken for by other creditors, you’ll have a tough time adding a new monthly payment. A high DTI indicates more potential risk for a lender, which might impact your ability to get approved for a home loan.
A low debt-to-income ratio is a positive signal, indicating that you have the available income necessary to make your mortgage payments. When you carry less debt, it can lead to a quicker mortgage loan approval, better interest rates and more favorable loan terms.
How Your Debt-to-Income Ratio Impacts Your Mortgage Approval
The ideal DTI ratio for a conventional home loan is usually at or below 36%. However, each lender sets its own requirements, which may vary by loan type and other borrowing factors.
If your DTI ratio is higher than 36%, it doesn’t mean you won’t be able to buy a home. Most lenders have some flexibility if you meet other criteria as part of your mortgage application. Along with your debt-to-income ratio, a lender will typically review information that includes your credit score, down payment amount and cash reserves.
- Conventional loans typically have a maximum DTI ratio of 36%, but this can go as high as 45% for borrowers who meet credit score and savings eligibility requirements.
- Standard FHA loans allow for a DTI ratio of up to 43% or as high as 45% if you meet other requirements.
- VA loans are capped at a DTI ratio of 41%.
- USDA loans target a maximum DTI ratio of 41% but allow as much as 44% with a credit score of 680.
Front-End vs. Back-End Debt-to-Income Ratio
When you apply for a mortgage, your lender might use these two calculations to evaluate your financial standing. Your back-end debt-to-income ratio is considered more important since it provides the clearest measurement of your monthly debts and ability to make payments.
- Front-end DTI: Also known as the housing-to-income ratio, compares your current housing expenses to your gross income. It takes into account things like your mortgage payment (or rent), property taxes, homeowners insurance premiums, private mortgage insurance (PMI) premiums and homeowners association (HOA) dues.
- Back-end DTI: When a lender refers to your debt-to-income ratio, they are generally talking about back-end DTI. This calculation includes all of your expenses and debt obligations, comparing them with your gross income.
How to Improve Your Debt-to-Income Ratio
To lower your debt-to-income ratio, you can increase your income or pay off debt.
Increasing your income might mean switching jobs, asking for a raise, applying for a promotion, or taking on a side hustle. Every extra dollar you can earn will help boost your bank account and improve your DTI ratio.
You can also work to chip away at your debt burden. This could include paying down your credit card balances to lower your monthly payments (or eliminate that debt). You might also consolidate or refinance any existing high-interest debt, which could reduce your monthly payment obligations and allow you to pay those debts off more quickly.
Mistakes that Can Hurt Your DTI Ratio
You should avoid taking on new debts if you’re seeking a mortgage preapproval. It’s also wise to gauge how future expenses could impact your debt-to-income ratio after you’ve purchased a home, especially if you plan to move or refinance at some point in the future.
Consider the impact that new auto loans, childcare costs or home renovation costs could have on your debt-to-income ratio.
The Bottom Line: Debt to Income Ratio for Mortgage Approval
Lenders consider the debt-to-income ratio when evaluating potential homebuyers. Your DTI gives a much clearer financial picture than just looking at your income alone, showing how much of that income you have available to spend.
Each lender has its own DTI requirements, but generally, you’ll want this number to be as low as possible to get mortgage loan approval and lock in the best terms. Before buying a home, review your financial standing and calculate your DTI. If this number is close to or above 36%, it might be wise to improve it before shopping for a new home or applying for a mortgage.
Debt-to-Income Ratio FAQs
What is a good debt-to-income ratio?
Most lenders view a DTI ratio of around 36% as favorable for a conventional home loan. In general, though, the lower your DTI, the better your chances of mortgage approval and the more favorable loan terms you can lock in.
Can I buy a home with a DTI of 50%?
A DTI ratio of 50% is generally considered too high to get approved by most mortgage lenders. While some can manually underwrite a home loan to allow for a higher DTI ratio, lenders typically cap this out between 44% and 46%. Borrowers with a higher level of debt will also be required to meet credit score and/or cash reserve requirements to qualify for a home loan.
Is rent included in a DTI calculation?
Yes, housing expenses like rent or mortgage principal and interest are included in the debt-to-income ratio calculation that lenders use. Housing costs like homeowners (or renters) insurance, HOA dues, PMI and property taxes are also factored into your DTI ratio.
Stephanie Colestock, CFEI, is an experienced freelance writer whose work can be found in publications such as TIME, Newsweek, USA Today, Fortune, Yahoo! Finance, Money and Fox Business. In addition to writing real estate and financial content, she is also a property investor and runs a local real estate collaborative for women called She Owns Homes.
