Debt-to-income (DTI) ratio compares how much you earn to your total monthly debt payments. Understanding your DTI is crucial if you are thinking about buying a home or refinancing a mortgage.
Crunch the numbers with Money’s DTI ratio calculator and find out if you’re ready to apply for a home loan.
- What is Debt-to-Income Ratio?
- How to Calculate Debt-to-Income Ratio
- How Does Your DTI Ratio Affect You?
- How to Lower your DTI Ratio
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 gross income goes into paying off their current debt. Gross monthly income refers to the sum total of your monthly earnings before taxes and deductions.
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.
How to Calculate Debt-to-Income Ratio
To calculate your debt-to-income ratio, first add up your monthly bills, such as rent or monthly mortgage payments, student loan payments, car payments, minimum credit card payments, and other regular payments. Then, divide the total by your gross monthly income (some calculators do request your gross annual income instead).
Your gross annual income includes wages, salaries, freelance income, overtime pay, commissions, tips and other allowances, etc.
What is included in your debt-to-income ratio?
Your DTI ratio should include all revolving and installment debts — 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.
Monthly expenses like rent, health insurance premiums, transportation costs, 401k or IRA contributions, and bills for utilities and services (electricity, water, gas, internet, and cable, etc.) are generally not included. However, if you have long-overdue bills for these types of accounts, they might eventually be passed on to a collection agency. The debt may be included in the calculation if that is the case.
There are two types of DTI ratios that lenders look at when considering a mortgage application: front-end and back-end.
What is your front-end ratio?
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.
What is your back-end ratio?
The back-end-DTI ratio considers what portion of your income is needed to cover your monthly debt obligations, including future mortgage payments and housing expenses. This is the number most lenders focus on, as it gives a broad picture of an applicant’s monthly spending and the relationship between income and overall debt.
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.
When do you include your spouse’s debt?
Including your spouse’s debt depends on whether you’ll be applying for the mortgage jointly or as an individual. Certain states operate under community property rules, which establish that both spouses are under equal obligation to repay debts incurred during the marriage. In those states, excluding a spouse’s debt from the DTI ratio is not allowed.
States where community property rules apply are:
- New Mexico
In the rest of the country (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.
In common-law states, applying as a couple is favorable if the combined debt results in a lower, stronger DTI ratio. Having two incomes also means that you could qualify for larger loans.
However, if a couple’s combined credit score and debt-to-income ratio severely impacts their eligibility for a good mortgage loan, it’s best to apply as an individual.
How Does Your DTI Ratio Affect You?
Your debt-to-income ratio affects your chances of qualifying for a mortgage. The lower your DTI, the more likely you are to qualify for a home-related loan.
Your debt-to-income ratio also determines whether you're eligible for the type of loan you want, and improving your DTI can help you get lower mortgage rates.
Lenders factor DTI for mortgage loans, mortgage refinancing, and home equity products. You can calculate these using our free mortgage calculator.
What is the debt-to-income ratio to qualify for a mortgage?
The debt-to-income ratio directly factors into whether a lender will approve your mortgage loan application or not. When buying your first home, your DTI is calculated with the estimated payments, taxes, and fees from the purchase. Depending on your credit score, savings, and down payment, lenders may accept higher ratios.
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%.
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%. Consider one of the best VA loans if you are considering this type of mortgage.
- Veterans United recommends a DTI of 41% or lower, with mortgage debt included in the DTI 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 strong credit history) that vouch for the applicant’s ability to repay.
- FHA loan 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.
To make sure you get a good deal on your mortgage, pick one of the best mortgage lenders of the year
What should your debt-to-income ratio be to refinance?
Creditors will also consider your DTI ratio when applying for a mortgage refinance. As with mortgage loans, a higher DTI will make it much harder to get approved for refinancing your home loan. Check our refinance calculator to determine if refinancing your mortgage is the right choice for you.
- For cash-out refinance, Chase recommends that consumers have a DTI of 40% or lower.
- Rocket Mortgage states that most lenders prefer consumers which have a DTI of 50% or lower when applying for mortgage refinance.
What is the debt-to-income ratio to qualify for a home equity loan?
DTI ratio affects how much of your home equity you can access. In addition to loan-to-value and combined loan-to-value ratios, lenders will consider your DTI when you apply for a home equity loan or line of credit.
Home equity loans have more stringent requirements than mortgages. Borrowers must have a 43% DTI or lower to qualify, in most cases, and some lenders may even require DTIs as low as 36%. Here are some examples:
- Because of the stricter requirements for home equity loans, Quicken Loans recommends that potential borrowers maintain a DTI of 43% or lower.
- Veterans United does not impose a maximum DTI ratio for Veterans and military members. However, those with a DTI above 41% may encounter additional financial scrutiny.
- Rocket Mortgage will not offer home equity loans to anyone with a DTI higher than 43%.
How much does your debt-to-income ratio affect your credit score?
Your DTI never directly affects your credit score or credit report. Credit-reporting agencies may know your income but they don’t include it in their calculations. Your creditworthiness is still factored into your home loan application. However, borrowers with a high DTI ratio may have a high credit utilization ratio — which accounts for 30 percent of your credit score. Lowering your credit utilization ratio will help boost your credit score and lower your DTI ratio because you are paying down more debt.
How To Lower Your DTI 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 – You’ll get a better overview of your spending habits and see where it’s possible to limit spending. If a pen and paper aren’t for you, there are secure budgeting apps that can streamline this process.
- Boost your income – Negotiate a higher salary or add a side income, such as renting out a spare room or delivering food.
- Focus on loan payments – Pay off your loans ahead of schedule. Alternatively, extend the duration of your loans to lower your monthly payments.
- Target debt with a high ‘bill-to-balance’ ratio – This helps reduce your DTI the most for the least amount of cash paid. Experts also recommend paying off your auto loan before applying for a mortgage.
- Look into federal loan forgiveness – Student loans may qualify for federal loan forgiveness, provided you meet certain conditions. If this isn’t an option, evaluate our list of the best student loan refinance companies to see if refinancing is viable.
- Refinance or consolidate your debt – Through debt consolidation or refinancing, you can use balance transfers to lower the interest rate on your loans. If refinancing, we recommend that you choose one of the best mortgage refinance companies of the year.
- Apply with a co-borrower with a lower DTI – A combined income along with their DTI can improve your approval rates, but make sure that their credit score doesn’t work against you. Postpone any large purchases with credit, until the application process is complete.
Both calculations evaluate your risk as a borrower, but consider different factors of your financial profile.
The DTI ratio considers your income and all monthly debt obligations to see how much money goes into paying off your debt. Lending institutions use the DTI ratio to evaluate borrowers, but it doesn't impact your credit score.
The credit utilization rate is a key evaluating factor of your credit score. This calculation measures your credit usage by comparing your maximum credit limit to your outstanding balance. Unlike the DTI ratio, the credit utilization rate only considers revolving credit — credit cards, personal credit lines and HELOCs. It doesn't factor in installment debt or your monthly income.