Buying a new home is exciting, but the process can be confusing and filled with unfamiliar terms. Along the way, you will likely hear about your debt-to-income ratio (DTI) and how it can affect your qualification
Your DTI is the percentage of your monthly income devoted to paying debts. Mortgage lenders include this ratio to determine your ability to repay a loan.
What is the ideal debt-to-income ratio for a mortgage?
A low DTI means you have a good balance between debt and income, so a lower percentage increases your chances of approval. Lenders consider a DTI of 36% as a good ratio — with no more than 28% of that going toward your mortgage. The lower your DTI, the more competitive your mortgage rates will be.
How to calculate debt-to-income ratio for mortgages
Follow these instructions to calculate your DTI ratio:
- Enter the total monthly amount you pay toward your credit cards, car loans and mortgages.
- Add up your remaining monthly debt payments — such as student loans or line of credit — and enter the number under Other loan payments.
- Enter your monthly income.
- Click Calculate. You’ll see your DTI ratio to the right of the calculator with a brief description of what that means to your creditors and lenders.
Calculate what percentage of your income is allotted to debt.
Fill out the form and click "Calculate" to see your DTI ratio.
What is the maximum debt-to-income ratio for mortgages?
In general, 43% is the maximum debt-to-income ratio that mortgage lenders accept. However, an ideal front-end ratio, or amount you spend on your mortgage, is 28% and 36% is ideal for a back-end ratio — what you spend on the rest of your bills.
Why is the DTI ratio so important for mortgages?
When lenders issue any type of loan, there’s always a risk of the borrower defaulting, so your interest rate is essentially a premium for the lender’s assumed risk. If you have a high DTI, it means that a good portion of your earnings already goes towards debts, which could affect your ability to make mortgage payments. Before your application is approved, lenders evaluate your DTI to determine your ability to repay the loan.
Types of debt-to-income ratios for mortgages
There are two parts to calculating your DTI:
- Front-end ratio: The percentage of income that goes toward housing costs. It’s calculated by dividing either your monthly rent or PITI — principal, interest, taxes and insurance — by your gross monthly income. Aim to keep this number under 28%.
- Back-end ratio: The percentage of income that goes toward recurring debts — including rent or PITI — calculated by dividing the sum of all debts by your gross monthly income. Aim to keep this number under 36%
Lenders look at both ratios when deciding your mortgage rate, but the back-end ratio is most important because it represents your total overall debt.
Case study:
For example, say you make $4,000 a month and spend $400 on a monthly car payment, $400 on your credit card bill and $800 on rent. This gives you a front-end DTI of 20% and a back-end ratio of 40%.
There’s a good chance you would be approved for a qualified mortgage, but the rate you’ll get depends on your lender’s preference for a front- or back-end ratio. For example, your front-end ratio could fall under the 28% cutoff, but you might not get the best rate if your back-end ratio exceeds 36%.
MUST READ: The qualified mortgage rule
A qualified mortgage is a type of home loan that’s designed to be fair to borrowers. Lenders issuing this type of loan must meet certain requirements to ensure that you can afford to repay the mortgage.
Some of these requirements include prohibiting certain risky loan features or excess points and fees. And most importantly, it ensures lenders don’t lend to you with a debt-to-income ratio below 43%. However, qualified mortgage requirements don’t apply if you’re eligible to purchase through Fannie Mae, Freddie Mac or the FHA.
How can I improve my debt-to-income ratio?
If you’re having trouble getting approved for a mortgage or simply want a better rate, there are a few ways to improve your DTI:
- Pay off debt. The simplest way to lower your DTI is to reduce your debt. You can do this by paying down your current debts faster — which will raise your DTI initially, but significantly reduce it in the long run.
- Postpone large purchases. If you know you’ll be applying for a mortgage soon, try to postpone any large purchases, as they’ll increase your DTI.
- Refinancing. Refinancing high-interest debts reduces your interest rate, meaning more of your money goes towards the principal and the debt will be paid off sooner.
- Increase your income. A part-time job, pay raise, or any other increase to your monthly earnings reduces your debt relative to your income.
- Consolidate. If you have debts, consider consolidating to reduce your monthly minimum payment.
Don’t apply if your DTI is high
Your DTI is the most important factor when determining your mortgage rate — but your credit score and other expenses matter, too. DTI calculations don’t include monthly obligations such as insurance and utility payments, or food and entertainment costs. A high DTI could mean struggling to cover your mortgage payments and monthly expenses. So wait until your have a lower DTI ratio to get a good rae and avoid taking out a loan you can’t afford.
How student debt affects DTI for FHA loans
If you’re a first-time homebuyer with student loan debt, the great news is — it’s going to get a lot easier to qualify for an FHA loan.
An FHA loan is a type of mortgage backed by the Federal Housing Administration (FHA). To qualify for an FHA loan, you generally must have a FICO score of at least 580 and a debt-to-income ratio (DTI) of 43% or less, including student loans.
Under the old FHA lending guidelines, 1% of your student loan balance goes toward your DTI. If your student loan balance is $100,000, that means $1,000 goes toward calculating your DTI ratio. But under the new guidelines, income-based repayments (IBR) are used instead of this 1% figure.
So, if you’re actually making a $200 per month income-based payment toward your $100,000 student loan, only $200 goes into your DTI calculation — not $1,000. This means it will be a lot easier to meet the DTI requirement for an FHA loan.
The new FHA lending guidelines go into effect on August 16, 2021.
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Bottom line
Your debt-to-income ratio is an essential measure that lenders consider when you apply for a mortgage. Whether you’re currently home shopping or preparing for the future, use the DTI calculator to find out where you stand.
Once you’re ready to apply, shop around and compare home loans to find the best option for your situation.
Frequently asked questions
Will a lower DTI get me better mortgage rates?
In most cases, yes. A lower DTI reflects a strong ability to repay a loan, so the reduced risk to the lender could be rewarded with a better mortgage rate.
Does debt-to-income ratio include student loans?
Yes. Your DTI ratio covers all types of debt, including but not limited to student loans, car payments, credit card bills and more.
You can learn more with our article on how student loans affect your DTI.
What do I do if my debt-to-income ratio is too high?
If your DTI is too high and you’re not getting approved for a mortgage, consider taking some time to reduce it before applying again. Look for ways to pay off and refinance debt or increase your income, then reapply once your DTI has fallen to 45% or below.
Is debt-to-income ratio pretax?
No. Your DTI is calculated using your post-tax income.
What is the maximum DTI for FHA loans?
The limit for FHA loans is generally 43% — but with compensating factors like excellent credit, collateral or a cosigner. The back-end ratio can be as high as 50%.
