Debt-To-Income Ratio (DTI): What Is It And How Is It Calculated?

Did you know that the debt to income ratio determines how much you can borrow?

Balance scaleThe debt to income ratios are a common metric for determining the eligibility of a borrower for a conventional loan.

What Is Debt-To-Income Ratio for a Mortgage?

The abbreviation "DTI" stands for "debt to income. " It is the proportion of total debt to total income that a person carries at any given point in time. There are two debt to income ratios. The front end ratio which looks at the monthly payment and the back end ratio which takes into consideration the anticipated mortgage payment and monthly bills.

Front-End Debt to Income Ratio Calculation

The front-end ratio is used to determine the maximum mortgage payment that a borrower may make. The front-end ratio is also referred to as the payment ratio. To determine front end ratio, divide your monthly mortgage payment by your gross monthly income.

This estimate includes principal and interest, real estate taxes, homeowner's insurance, homeowner's association dues, mandatory maintenance fees, common charges within a development, private mortgage insurance, and maybe flood insurance.

The highest payment ratio is set by the loan program. If the borrower's front-end debt ratio exceeds the loan program's maximum, the borrower must lower the loan amount. Multiply your gross monthly income by 33% to estimate your mortgage payment.

To calculate the front end ratio, divide the anticipated monthly mortgage payment by the gross monthly income to arrive at the Front Ratio. This calculation takes into account principle and interest, real estate taxes, and homeowner's insurance, as well as homeowner's association dues, required maintenance fees, common charges within a development, and, if applicable, private mortgage insurance, and possibly flood insurance. Here's an example of the front end payment ratio:

  1. Monthly gross revenue = $6,000
  2. Mortgage payment estimate = $1,500
  3. Ratio of the Front End-$1,500/$6,000 = 25%

Back-End Debt to Income Ratio Calculation

The Back Ratio is similar to the front end ratio except that it includes the monthly loan payment, and monthly debt payments. Consumer debt payments include, but are not limited to, credit card bills, automobile payments, and personal or school loans. Alimony and child support payments are also included in the back end ratio calculation.

Insurance premiums for life, health, and auto are all examples of items that are often omitted from a back-end ratio. Here's an example of the back end ratio calculation:

Payment on proposed mortgage-$1,500 (includes taxes, insurance, PMI, if required)
Loan for automobiles-$100
Payments made through credit cards total $400.
TOTAL MONTHLY PAYMENTS = $2,000.

The monthly gross revenue is $6,000.00.
Debt-to-income ratio = $2,000/$6,000 = 33%

Most lenders look at your back end DTI because it gives them a more complete picture of how much you spend each month.

Back-end DTI provides lenders a more thorough view of your monthly spending.

Debt-to-Income Requirements Vary by Loan Program


FHA Mortgages

FHA logoMortgages insured by the Federal Housing Administration are known as FHA loans. FHA loans have looser credit score requirements. FHA loans have a maximum DTI of 57 percent, although the actual number is chosen on an individual basis. Read more about FHA mortgages at FHA Loan Plus

USDA Mortgages

USDA logoUSDA loans can only be used for rural property purchases or refinancing. To be eligible for a USDA loan, your debt-to-income ratio must be below 41%.

USDA loans include a few of specific requirements. To begin, in order to qualify for a loan from the USDA, your annual household income cannot be more than 115 percent of the local median income.

Your lender must consider the combined income of all family members when calculating your eligibility for a USDA loan. This means they must check the income of all residents, whether or not they're on the mortgage.

Your lender will only examine the income and responsibilities of those on the loan when determining your debt-to-income ratio (DTI). If there are other persons living in the residence, only their combined salaries will be considered. It won't affect DTI.
Read more about USDA mortgages at USDA Loan Plus

Veteran Mortgage (VA Loan)

VA mortgage logoCurrent and former members of the military can purchase a house at a reduced cost thanks to VA financing. VA loans offer forgiving debt-to-income ratios and do not need a down payment. In exceptional instances, a DTI of 60% may qualify you for a VA loan. The Veteran's Administration employs the residual income calculation in addition to the standard debt-to-income ratio.
Read more about VA mortgages at VA Loan Plus.

Conventional Mortgage

Conventional loan graphicThe DTI criteria for conventional loans varies depending on your personal circumstances and the credit you want. A DTI of 50% or less is frequently necessary for a conventional loan. In rare cases, a DTI of up to 65% may be acceptable.
Read more about Conventional Mortgages at Conventional Loan Plus

How do I reduce my debt to income ratio?

Prior to submitting a mortgage application, there are steps you may do to reduce your DTI, or debt-to-income ratio.

Pay off your smallest outstanding debts first, but don't pay them off.

Eliminating your monthly payments is the easiest method for decreasing the ratio of your debt to your income. If possible, you should prioritize paying down the smaller payments first, but you should not pay off these accounts.

According to Experian:

Reduce balances on revolving accounts.  Your credit utilization is calculated by taking the total of all your credit card balances and dividing it by the total of all your credit card limits. The lower your credit utilization rate, the better. Credit utilization above 30% can start to bring down your scores, and people with the best credit scores tend to keep their credit utilization below 10%. If possible, you should aim to pay your credit card balances off in full each month.

The Experian site has a wealth of information on improving your credit.

Increase Your Earnings

Your debt-to-income ratio (DTI) can be lowered by increasing the amount of money you bring in through freelancing, working additional hours at your existing job, or starting a side business. Bear in mind, however, that you will need to be able to demonstrate that the income you are now getting is consistent and will continue in the foreseeable future. In general, lenders like to see a history of at least two years for each source of income.

Consider Obtaining a Cosigner for Your Mortgage

If you are buying a home with a partner or spouse, your mortgage lender will use both of your incomes and debts to calculate your debt to income ratio. Adding your partner to your loan can lower your total household debt. Adding them to the loan may not help your situation if your partner's DTI is higher than yours. If that's the case, you can always ask a family member or close friend to cosign the mortgage loan with you. If you use a co signer, you may be able to qualify for a larger mortgage or lower interest rates.

Increase Your Down Payment

By increasing your down payment, you are lowering your mortgage payment and thereby reducing your debt to income ratio. Sounds simple, I know, but if you can obtain a monetary gift, that money could be used to reduce your loan balances.

Rotating Question markFrequently Asked Questions (FAQs)

Debt-to-income ratio impacts loan size and interest rate when buying a home. This ratio is more than meets the eye. Check the commonly asked questions to prepare for the application process.

Is all debt treated the same in my debt-to-income ratio?

Your ability to get a mortgage will depend on how much of your income you spend. The type of debt has nothing to do with the amount of debt. It will be harder for you to get a loan if you have a lot of debt. Payments for credit card debt, auto loans, and student loans are all handled the same way. The minimum payment on each account is all that matters to the lender.

How quickly can my debt to income be improved?

You can quickly raise your DTI by paying off your debt, since your ratio is based on how much debt you have at any given time. This is because your DTI depends on how much debt you have in total. Your ratio will get better and your mortgage application will look better in direct proportion to how quickly you pay off your debt. You can make more money in a number of ways, and getting a job is one of them.

Rapid Rescore

It might take some time for the credit bureaus to rescore your account. There could be a mistake on your credit report that is making your credit score go down. Or maybe you just paid off a few accounts, but your credit report isn't up to date.

So how do you clear up your credit report? Request that your lender use Rapid Rescore. How does it work? You will show the lender proof that your account has been paid or changed.

The lender will send your paperwork to one or more credit agencies so that your credit report and credit score can be reevaluated and changed.
Improving your credit score lowers your interest rate, mortgage payment, and debt-to-income ratio.

Paying down debt, but not too much

If you pay off your obligations in full, your credit score may drop. The credit scoring system is designed to look at all open accounts. Pay your accounts down, to 30% of the credit limit. Don't payoff your bills. See Experian above.

Should I apply for a mortgage that has a high DTI (debt-to-income ratio)?

If you have a high debt-to-income ratio, some lenders may not provide you a home loan or charge you a higher interest rate. But only in particular situations. You can still acquire a mortgage loan with a high DTI, but it's in your best interest to minimize it if possible to get a better interest rate.

Does my debt-to-income ratio (DTI) impact my credit score?

Debt-to-income ratio doesn't effect credit score. It tells you how much of your monthly income should go toward recurrent debt. If you pay the legal minimums on time each month, a high DTI does not automatically mean a low credit score. But it increases the chance.

Conclusion

In conclusion, your debt to income ratio is a major factor in your ability to buy a home. Lenders look at this ratio to see how much debt you can afford to take on in addition to your new mortgage. A high debt to income ratio means you are a higher risk borrower, and may not be able to get a loan at all. Try to keep your debt to income ratio as low as possible before buying a home.