What is the debt-to-income ratio (DTI)?

In a nutshell

Understanding and managing your debt-to-income (DTI) ratio is one of the most significant financial skills you can develop, especially when you’re considering buying a home.

• Your debt-to-income (DTI) ratio helps lenders determine whether you can realistically afford to take on more debt and another monthly loan payment.
• A lower DTI can improve your chances of loan approval and help you secure more competitive interest rates.
• With strategic planning and careful financial management, you can improve your DTI and increase your chances of getting approved for a mortgage.

What is the debt-to-income ratio?

The debt-to-income (DTI) ratio is a metric that compares your gross monthly income to your monthly debt payments. It's a way for lenders to gauge your ability to manage your existing monthly payments and whether you can take on more debt. There are two primary types of DTI ratios used in the mortgage industry: front-end and back-end.

Front-end DTI

The front-end DTI ratio — also known as the housing ratio — looks at your monthly housing expenses (including mortgage payment, homeowner's insurance and property taxes) and divides it by your gross monthly income.

The result is a percentage that lenders use to determine whether you can comfortably afford a monthly mortgage payment. Ideally, lenders look for a front-end DTI that doesn’t exceed 28% of your gross monthly income.

Back-end DTI

The back-end DTI factors in all debt obligations, including the estimated mortgage payment. This ratio gives a fuller picture because it helps lenders determine how the burden of all your debt compares to your income. The recommended maximum is typically around 36%, but that number will vary by lender.

What monthly payments are included in my debt-to-income ratio?

Several monthly payments are included in your DTI but must be monthly debt payments.

• Mortgage payment (principal, interest, taxes and insurance).
• Credit card payments.
• Auto loan payments.
• Student loan payments.
• Alimony or child support.
• Other personal loans.
• Any other debt that shows up on your credit report.

What payments should not be included in your debt-to-income ratio?

Not all of your monthly obligations are part of your debt-to-income ratio. These include:

• Regular monthly living costs, like groceries or utilities.
• Non-debt-related items, such as health insurance or gym memberships.
• Prepaid items or closing costs (unless they are placed in an escrow account).
• Current or future educational expenses.

What sources of income are considered?

When calculating your debt-to-income ratio, lenders will typically consider the following sources of income:

• Gross monthly income from your primary job.
• Additional income, such as bonuses, commissions and overtime pay.
• Self-employment income.
• Alimony or child support (if you choose to include these payments).
• Investments, like income from dividends or rental properties.

How does my debt-to-income ratio affect my ability to get a loan?

Your DTI ratio is critical in determining whether you qualify for a mortgage and how much you can afford. Lenders generally look more favorable on lower DTI ratios. A lower DTI can also mean better terms on your loan, such as a lower interest rate or a lower down payment.

High DTI ratios, on the other hand, can indicate that you might struggle to make loan payments and are at a higher risk of default. Lenders may be more hesitant to loan to individuals with high DTI ratios, or they may require a larger down payment and charge a higher interest rate.

How to calculate your debt-to-income ratio

Calculating your debt-to-income ratio is simple.

• Calculate your monthly debt payments, which includes your mortgage payment, credit card payments, auto loans, student loans and any other debt obligations.
• Calculate your gross monthly income, which includes your primary job income, additional income sources (bonuses, commissions, etc.) and any other regular sources of income.
• Divide your total monthly debt payments by your gross monthly income.

Here’s an example of how to calculate your DTI using dollar amounts.

John is looking to get a personal loan but has the following monthly debt obligations:

• Mortgage: $1,200.
• Car loan: $300.
• Student loan: $200.
• Credit cards: $150.

His gross monthly income is $4,000.

• John's total monthly debt payments are $1,850.
• His DTI is ($1,850 / $4,000) x 100 = 46.25%.

In this example, John's back-end DTI is 46.25%, which is high. Lenders may see this as a sign that John could have too many monthly payments to take on any additional debt.

What is considered a good debt-to-income ratio?

A good DTI ratio is generally 43% or lower. However, remember that “good” can be relative to the lender and the type of loan you're seeking. Some lenders may approve higher DTIs but with other compensating factors, such as a high credit score.

It's important to understand your debt-to-income ratio and take steps to improve it if necessary. A lower DTI not only improves your chances of qualifying for a mortgage but also indicates better overall financial health.

Some practical ways to lower your DTI include paying off existing debt, reducing monthly expenses and increasing your income through a raise or side hustle. It's essential to keep regular track of your DTI and make adjustments as needed to maintain a healthy ratio.

DTI requirements by mortgage type

​​Different mortgage types have different DTI requirements.

• Conventional Loans: These typically require a maximum DTI of 43%, but some lenders may accept higher ratios with compensating factors.
• FHA Loans: These are more flexible, allowing a front-end DTI as high as 31% and a back-end DTI as high as 50% in some cases.
• VA Loans: The Department of Veterans Affairs recommends a DTI of 41% or lower. However, lenders often approve higher ratios with strong credit and financial reserves.
• USDA Loans: These have a maximum back-end DTI of 41%.

The AP Buyline roundup

Your DTI is not the only important factor when it comes to getting a loan. Still, it is an essential tool in helping lenders determine your creditworthiness and your ability to handle additional debt. If you’re considering a loan soon, be sure to calculate your DTI and take steps to reduce it by paying down debt if necessary.

This will not only help you better qualify for a loan, but you’ll have an easier time managing monthly payments while avoiding spreading yourself too thin financially.

Frequently asked questions (FAQs)

What debt-to-income ratio is too high?

No set number is universally too high because it depends on the specifics of your financial situation and the lender's criteria. However, in general, if your back-end DTI is over 50%, you'll find it challenging to get a mortgage — with the exception of specialized loan programs with lenient standards on some of the other qualifying factors, such as credit scores.

Does lowering your debt-to-income ratio raise your credit score?

Lowering your DTI ratio may indirectly help your credit score. It can positively impact the "amounts owed" factor of your FICO credit score, which accounts for 30% of your total score. When you owe less money, you're considered less risky to lenders, which can improve your creditworthiness and, in turn, your credit score.

What is the fastest way to lower debt-to-income ratio?

To reduce your DTI quickly, avoid taking on new debt, such as new auto loans or lines of credit. You can also increase your income, if possible, by taking a part-time job or side gig. Remember, while lowering your DTI ratio is beneficial, it's equally important to maintain a healthy financial lifestyle overall.