If you are thinking about buying a home, understanding your debt-to-income ratio is crucial. Crunch the numbers with Money’s DTI ratio calculator.
What Is Debt-to-Income Ratio?
The debt-to-income (DTI) ratio is a key financial metric that lets lenders know how much of a borrower’s monthly income goes into paying off debt. A low DTI indicates that the consumer is a low-risk borrower while a high one is taken to mean that the person is at a higher risk of defaulting on their debts.
Typically expressed in percentages, DTI ratios are calculated by dividing monthly debt payments by gross monthly income, which refers to the sum total of your monthly earnings (wages, salaries, freelance income, overtime pay, commissions, tips and other allowances, etc.) before taxes and deductions.
According to Veterans United, mortgage lenders don’t value all income equally. Some income sources won’t be counted at all, while others, like self-employment income, often require at least a two-year history to count as effective income.
How Do We Calculate Your Results?
Once you input your monthly gross income and the total amount of your minimum monthly debt payments, our calculator divides your total monthly debt by your monthly gross income and outputs the result as a percentage. This number is your current DTI ratio.
What Should I Include Under Debts?
Your debt should include all revolving and installment debt — meaning car loans, personal loans, student loans, mortgage loans, credit card debt, and any other debt that shows up on a credit report. Certain financial obligations like child support and alimony should also be included.
Do not include monthly expenses like health insurance premiums, transportation costs, 401k or IRA contributions and bills for utilities and services (electricity, water, gas, internet, and cable, etc.). However, there is a caveat. If there are long overdue bills for these types of accounts, they might eventually be passed on to a collection agency responsible for recouping that money. If that is the case, the debt may be included in the calculation.
What’s a Good DTI for a Mortgage?
Lender limits can vary considerably, depending on the type of loan and overall financial profile of a prospective applicant, but there are guidelines in place that can serve as a frame of reference. Since the Federal National Mortgage Association (commonly known as Fannie Mae) raised their DTI limit in 2007, the maximum limit for most lenders will not exceed 50%.
However, that number is far from ideal. Prospective borrowers should strive for a DTI of at least 43%, or the maximum allowed to access Qualified Mortgage loans. These loans comply with federal guidelines that were created to prevent high-risk transactions between lenders and borrowers.
For some examples of what this looks like in real life, let’s look at some lenders:
- Quicken Loans sets their DTI limit at 50% for most of their loans, making an exception for VA loans, for which the DTI ratio limit can go up to 60%.
- Veterans United recommends a DTI of 41% or lower, with mortgage debt included in the calculation. Higher ratios may still be allowed, but borrowers with a DTI of 41% or higher will need to compensate by having a residual income that exceeds Veterans United’s guidelines by at least 20%.
- Better Mortgage offers loans to candidates with a DTI ratio as high as 47%
- Rocket Mortgage sets the limit at 50%
Loans guaranteed by the Federal Government have their own set of limits, as well:
- USDA loans set their limit at 29% for front-end-ratio and 41% for back-end-ratio, but allow each lender to approve candidates with higher percentages if there are compensating factors (such as supplemental income, generous savings or a strong credit score) that vouch for the applicant’s ability to repay.
- FHA limits can go up to 50%, but it depends a lot on the strength of other compensating factors, too. A low credit score can mean that your DTI ratio cannot exceed 45% in order to qualify, while a higher credit score will typically allow greater flexibility.
How To Lower Your Debt-to-Income Ratio
There are several strategies to lower your DTI. The goal is not only to reduce overall debt, but also how much you’ll pay on a monthly basis.
Start a Monthly Budget
This helps to have a better overview of your spending habits and see where it’s possible to cut costs. If a pen and paper isn’t for you, there are many secure budgeting apps that can streamline the process even more.
Increase your Monthly Payments
Prioritize accounts that have the highest minimum monthly payment. Better Mortgages, for instance, recommends paying off car loans before applying for a mortgage.
Reduce Credit Card Debt
Or pay them off entirely, if possible. Postpone large purchases and do not add more expenses to your credit.
Look into Refinancing or Consolidating your Loans
This can significantly reduce monthly payments. Adding a co-borrower with a lower DTI ratio is also a good strategy, but make sure that their credit score will not work against you.
Finally, see what options are available to increase monthly income, whether by asking for a raise or finding a second source of stable income.
How COVID-19 Has Affected the Mortgage Market
The Federal Reserve regulates interest rates in response to economic activity. It lowers them to boost activity in times of economic slowdown or recession and, conversely, raises them if the economy is booming, to encourage a slow-down and curb inflation.
Low interest rates make it more affordable for businesses and consumers to borrow, invest and spend more, whereas higher rates have the opposite effect.
While the Federal Reserve had been slowly lowering interest rates since 2019, the outbreak of COVID-19 forced the central bank to move at a more drastic pace, in an attempt to offset the economic impact of the pandemic.
This has represented a big boost to the housing market, as many homeowners are taking advantage of the low interest rates to refinance their mortgages and potential buyers are motivated to shop for offers they would not have been able to afford before.
Nobody can time the market, but these rates are worth taking advantage of. They’re projected to remain in place until at least 2023, as part of an effort to re-strengthen the economy. Although they affect parts of the economy differently, homeowners and buyers in the housing market today stand to gain long-term mortgage benefits that might not be available again in the near future.
Lock in the Lowest Rates in History
A lock-in on a mortgage loan means that the current interest rate for that offer is fixed for up to 60 days and won’t change until the mortgage is closed. It’s important to thoroughly think that timeframe through. If the closing process extends past the specified date, the lock-in is no longer valid. You may then have to pay extra to have the lock-in extended or accept whatever the current interest rate at that later time.
We recommend getting multiple quotes from lenders on the same day. Mortgage quotes can expire fast because rates change daily, and even hourly. Getting your quotes during the same day (or during a short timeframe) will help make accurate comparisons.
There’s another benefit, as well. Before giving a quote, lenders need to check your credit report with a hard pull.
Getting many hard pulls during an extended period of time can negatively affect your score and bring it down considerably. However, multiple hard checks for car or mortgage loans count as only one inquiry if they are made within a 45-day window (or 14 days in some cases). This allows you to shop around for a good offer without damaging your credit score in the process.
Compare, contrast, and once you’ve selected the best offer, lock one in.
Why Getting Pre-Approved Is Important
Getting a pre-approval shows sellers that the buyer has serious interests in the property and is not just casually shopping around. It demonstrates that their credit and finances have been vouched for by potential lenders, and gives the buyer a competitive edge, as sellers are more likely to consider an offer if it comes from someone pre-approved.
Pre-approval also helps homebuyers have a more realistic approach when shopping because they have a clearer idea of what they can actually afford to borrow and what houses and areas are worth looking at.
Finally, many real estate agents will require pre-approval in order to work with you. Make sure that your lender performs a soft pull on your credit for the pre-approval, and not a hard check, so that your credit isn’t affected.
Debt to Income Ratio FAQ
Why is the DTI ratio important?
Lenders use DTI ratios to determine whether someone is financially secure enough to manage monthly loan payments. A high DTI ratio is seen as riskier for default. A low DTI ratio indicates that the borrower will be able to make payments even with a hit to their income.
What’s the difference between front-end and back-end DTI ratios?
The back-end-DTI ratio considers all monthly debt payments (including future mortgage expenses) against monthly income. This is the number most lenders focus on. It gives a broad picture of an applicant’s monthly spending and the relationship between income and overall debt.
The front-end-DTI ratio, also called the housing ratio, only looks at how much of an applicant’s gross income is spent on housing costs, including principal, interest, taxes, and insurance.
A general rule would be to work towards a back-end-ratio of 36% or lower, with a front-end-ratio that does not exceed 28%. Mortgage expenses should not take up more than 28% of your income.
What’s a good Debt-to-Income Ratio?
While a good DTI ratio should fall between 36% to 43% — the lower, the better. A DTI higher than 43% is seen as a sign of financial stress. While it does not disqualify the borrower, it will make it more difficult to get a good loan offer.
Does my Debt-to-Income ratio affect my credit score?
Your DTI never directly affects your credit score or credit report. Still, many lenders will take it into consideration when evaluating you as a borrower, since your DTI is viewed as a good indicator of your ability to repay a loan.
Should I include my spouse’s debt?
Including your spouse’s debt depends on whether you’ll be applying for the mortgage jointly or as an individual — as determined by state law. In Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin, community property rules come into play.
These rules establish that both spouses are under equal obligation to repay debts incurred during the marriage, so it is not an option to exclude a spouse’s debt from the DTI ratio. Applying for a loan as an individual is still allowed, but lenders will nevertheless consider spousal debt and income in their calculations, even if they are not on the loan.
In the rest of the states (including Alaska, which allows couples to opt out of community property rules) common-law rules apply. Couples are not legally obligated to equally share all debt acquired while married. This means they can apply for a loan as individuals and the spouse’s income and debt will bear no influence in the lender’s evaluation.
The choice to apply as a couple depends on how beneficial it is for you. Having two incomes available means that you could qualify for larger loans. Combined debt and income could give a lower, stronger DTI ratio. If this is the case, applying as a couple would be ideal and you should include your spouse’s debt in the calculation.
However, if a couple’s combined credit score and debt-to-income ratio severely affect the prospects of qualifying for a good mortgage, it might be better to apply as an individual.