How to Calculate Your Debt-to-Income Ratio
One of the main factors mortgage lenders consider when determining your ability to afford a home loan is your debt-to-income (DTI) ratio.
Your DTI ratio is the relationship between your monthly debt payments and gross monthly income. When you calculate DTI, the ratio is expressed as a percentage.
There are two types of DTI ratios — front-end ratio and back-end ratio. The front-end DTI ratio is the percentage of your monthly income that is dedicated to paying your housing expenses, which include your monthly mortgage payment, plus taxes and insurance. The back-end DTI ratio focuses on all your debt, including your housing expenses. Mortgage lenders are often more concerned with the back-end ratio.
We will walk you through how to calculate your DTI ratio and explain its significance in the mortgage lending process.
Calculating your DTI ratio
How is debt-to-income ratio calculated for mortgages? Below, we highlight the steps:
- Determine your gross monthly income — the amount you earn each month before any deductions — from all documented sources.
- Establish your estimated monthly mortgage payment, using the acronym PITI as a guide: principal, interest, taxes and insurance.
- Add up your other monthly debt payments (outside of your housing expenses). Be sure to include any credit card or loan payments.
- Take your monthly mortgage payment and other debt payments and add them together. Divide that total by your gross monthly income amount.
Here’s an example of how to calculate a DTI ratio:
In the example above, the homebuyer’s debt-to-income ratio is 35%, which means 35% of their gross monthly income is dedicated to repaying debt. Let’s take a deeper dive into what’s involved in each step of calculating DTI.
Determine your gross monthly income
Your gross monthly income is the amount you earn from employment before income taxes and other costs are deducted from your pay.
Write down your monthly gross income amount(s). If you are paid weekly, multiply your weekly gross income by 52, then divide by 12. If you are paid every two weeks, multiply your biweekly pay by 26, then divide by 12.
Establish your estimated monthly mortgage payment
Pull your estimated monthly mortgage payment from your Loan Estimate. The amount should not only include your principal and interest payment, but estimates for property taxes, homeowners insurance and, if applicable, mortgage insurance.
Add up your other monthly debt payments
Make a list of your required minimum payment for all your other monthly debt payments, which can be found on your most recent account statements. Even if you pay more than the minimum, you should only list the minimum payment amount. These payments would include any fixed or variable accounts that are paid each month, such as:
Don’t include utility bills or miscellaneous expenses.
Run the numbers
Now that you have the amounts for your gross monthly income and monthly debt payments, you’re ready to calculate your debt-to-income ratio.
Add up your estimated mortgage payment and required minimum payment amounts for all your debt accounts. Write down the total. Then, divide the total of your estimated mortgage payment and other debt payments by your gross monthly income amount.
Using the example above, suppose that your estimated mortgage payment is $1,200 and your total minimum payments on your other debts is $700. The combined total for all your debt payments would be $1,900.
You would then take the $1,900 and divide it by your gross monthly income of $5,500. The result is a DTI ratio of 0.345. You would multiply that by 100 to get the percentage amount of 34.54%, which could be rounded up to 35%.
Why your DTI ratio matters
A low DTI ratio demonstrates that you can manage your existing debt and afford a mortgage. But a higher DTI ratio may prevent you from qualifying for a mortgage because it shows your budget is stretched too thin. In other words, you don’t have enough income to cover more debt.
Mortgage lenders establish maximum acceptable debt-to-income ratios as part of the process of approving home loans. Acceptable DTI ratios can change as mortgage lenders and other authorities revise their mortgage approval guidelines, but the often-cited rule of thumb is to keep your front-end ratio below 31% and your back-end ratio at or below 43%.
Generally speaking, maximum back-end DTI ratios for the following loan types are:
- Conventional: 45%
- Federal Housing Administration (FHA): 43%
- U.S Department of Agriculture (USDA): 41%
- Veterans Affairs (VA): 41%
A lower DTI ratio can obviously work in your favor. The average DTI ratio for all mortgages closed in June 2019 — the most recent month for which data was available — was 38%, according to Ellie Mae’s Origination Insight Report.
Can your DTI ratio affect your credit?
The short answer is no, though there are factors on your credit report that play into your DTI ratio. Your minimum payments, which are reported to the credit bureaus by your creditors and lenders, are used to help calculate your DTI ratio. So the less debt you owe, the lower your DTI ratio is likely to be, which might even lead to a higher score.
How to improve your DTI ratio
Consider the following tips to help you improve your debt-to-income ratio — especially the back-end calculation.
- Reduce your credit card balances. If you’re close to the limit on any of your credit cards, pay down those balances. It’s best to keep your credit utilization low, which means the revolving balance on each of your cards should stay below 30%. If your card has a $1,000 credit limit, you shouldn’t carry a balance that exceeds $300. Not only does this help improve your credit score, but it can lower your minimum credit card payment, which can also improve your DTI ratio.
- Pay off any debts you can. If you have an auto loan, personal loan or other account with a relatively smaller balance, focus on getting rid of that debt before applying for a mortgage. That way, there would be at least one less minimum payment to add to your DTI ratio calculation.
- Increase your income. Do you have time in your weekly schedule to earn more money? Consider taking on a part-time job or side hustle. This can increase your annual earnings and ultimately lower your DTI ratio.
The bottom line
Mortgage approval requirements vary between loan programs and among lenders. If your debt-to-income ratio doesn’t work with one lender, try another. It’s a good financial habit to shop around before settling with one company.
Not only can comparison shopping help you find the best mortgage lender for your unique financial situation, but it can save you money. Taking the time to shop for the best rate could translate into an interest savings of tens of thousands of dollars over the life of a 30-year, fixed-rate $300,000 mortgage, according to LendingTree’s Mortgage Rate Competition Index.
And don’t be afraid to ask questions. If your DTI ratio is too high, don’t give up — ask about other mortgage programs or suggestions for reducing your debt load.
Finally, boost your chances at approval by taking the time to fully understand the minimum mortgage requirements for each mortgage type before you apply.
The information in this article is accurate as of the date of publishing.