Here’s How to Calculate Your Debt-to-Income Ratio — And Why Mortgage Lenders Use It to Evaluate You

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When you apply for a mortgage, your lender will take a deep dive into your finances to determine if you qualify for the loan. Along with your credit score and income, one of the factors your lender will look most closely at is your debt-to-income ratio.

Debt-to-income ratio helps lenders determine how much house you can afford by showing the percentage of your monthly income that goes toward your outstanding debts. In this article, we’ll explain exactly what debt-to-income ratio is, how it applies to mortgages, and how you can reduce yours to better qualify for a mortgage.

What is Debt-to-Income Ratio?

Debt-to-income ratio (DTI) is the percentage of your gross monthly income that goes toward your current debts. Rather than looking at your total debt amount, the ratio only takes into account your monthly debt payments as they relate to your monthly income.

DTI is one of the most important metrics of your financial health, and it’s commonly used by lenders to determine your creditworthiness. In general, a low DTI shows that only a small portion of your income goes toward debt, leaving more money available for savings, expenses, and other financial obligations — like paying a mortgage.

How Is Debt-to-Income Ratio Calculated?

Calculating your DTI requires dividing your minimum monthly debt payments by your gross monthly income. It’s important to note that gross income includes all of your income, before deducting any taxes or expenses. 

Suppose you have a gross annual income of $60,000 per year, which breaks down to $5,000 per month (before taxes). You have a student loan with a monthly payment of $200, an auto loan with a monthly payment of $275, and a credit card debt balance with a minimum monthly payment of $90.

Your total debt payments add up to $565 per month. When you divide that by your gross monthly income of $5,000 per month, you’ll find that you have a DTI of 11.3%. When you apply for any type of loan, a lender is likely to look at this number and how new debt would affect it. Taking on new debt will increase your DTI, while reducing your debt or increasing your income will decrease your DTI. 

Pro Tip

If you’re considering buying a home, do the math to calculate your debt-to-income ratio to learn if you’re likely to qualify for a mortgage or if you’ll need to spend a bit more time getting your finances ready.

DTI and Mortgages

DTI is one of the most important metrics that mortgage lenders consider when determining if someone qualifies for the home loan they’re applying for. This is partially due to regulatory measures put in place after the financial crises in the late 2000s, according to Robert Heck, the VP of Mortgage at the online mortgage marketplace Morty.

“At this point, almost every loan program has some concept of the ability to repay, that’s being embedded into the lender’s process for evaluating a consumer,” Heck says. “DTI is one of the biggest measures for the ability to repay. When I say ‘ability to repay,’ it’s just the lender’s best assessment of a borrower’s ability to make ongoing payments once they’ve taken out the mortgage.”

The DTI that a lender will require for a mortgage depends on several factors, including the type of loan you’re taking out. Certain government loans, like FHA loans or USDA loans, may have specific requirements when it comes to DTI. Additionally, other metrics of your financial health may result in the lender requiring a lower than normal DTI. In general, having a lower DTI will help to increase your chances of being approved for a mortgage.

There are a lot of other factors that go into determining the maximum DTI, including the down payment and the home the buyer is looking to purchase, according to Heck. A good rule of thumb for the recommended maximum DTI is 50%, he says. “But if there are additional risk factors like a lower down payment or lower credit score, then the maximum DTI ratio may come down to 45%, 43%, or 36%,” he adds. 

Lenders are also likely to consider your front-end DTI, which is the percentage of your monthly income that goes toward housing. This will usually be a different number than your back-end DTI, or the percentage of your income that goes toward all your debts. Lenders generally want your front-end DTI to be less than 28%.

Should You Apply for a Mortgage with a High DTI?

The average non-mortgage debt per person in 2021 was $25,112, according to a report by the credit bureau Experian. Unfortunately, these high debt balances can make it more difficult to qualify for a mortgage. You might find yourself wondering if it’s worth applying for a mortgage with a DTI that’s near the top of your lender’s allowed range.

First, know that there’s little harm in simply applying for preapproval to see if you might qualify for a loan and how much you might qualify for. While there will be a hard inquiry on your credit report that might lower your credit score by a few points, it can provide you with some valuable information.

Next, consider what your monthly budget would look like with a mortgage payment. The DTI requirements are there to reduce the risk for the lender, but they also help protect you as the borrower from getting in over your head.

“You don’t want to stretch yourself too thin and become house poor, which is when you buy as much home as possible, and then it takes up a majority of your income each month and you’re penny-pinching or can’t save for other goals,” says Brittney Castro, the in-house CFP for the financial planning app Mint and the founder and CEO of Financially Wise.

Look at how your budget would change after taking out a mortgage and how much your housing costs would increase. Don’t forget to include other costs associated with homeownership, such as maintenance expenses, property taxes, and homeowners insurance. You’ll have to decide for yourself whether you feel comfortable with the results.

How to Lower Your DTI Ratio

If your DTI is preventing you from qualifying for the mortgage you want, there are some steps you can take to reduce it: 

Pay Off Debt

One of the most effective ways of reducing your DTI is paying off debt. While it’s often easier said than done, reducing the amount of debt you have can help you reduce your monthly payments, and therefore the percentage of your monthly income going toward debt.

Aside from lowering your DTI, paying off your debt can also improve your credit score by reducing your credit utilization ratio, which is your total debt divided by your total available credit. A higher credit score could help improve your chances of qualifying for a mortgage or getting a favorable interest rate

Increase Your Income

Increasing your income is another way to reduce your DTI. Not only will you have a higher gross income for the calculation, but you’ll also have the opportunity to put more money towards your debt, which can further reduce your DTI. 

A few ways you might increase your income include switching jobs, negotiating a raise at your current job, working overtime hours, or picking up a second job or side hustle.

Lower Your Monthly Payments

DTI doesn’t consider the full amount of debt you have — it only takes into account the amount of your income going toward your debt each month. By reducing your monthly payments, you can reduce the percentage of your income being used for debt.

There are several ways to lower your monthly payments, including refinancing your loans or negotiating the interest rate on your debt. While negotiating your interest rate may be possible for credit cards, installment loans — like personal loans, auto loans, or student loans — will likely require a refinance to adjust the rate.

Reduce Your Non-Essential Spending

“Look at where your money is going every month and cut back as much as you can,” Castro advises. “A lot of times, we find out that we’re paying for things like subscriptions we no longer need. Really getting on top of your monthly numbers, your spending, your expenses, is going to be so helpful, because you’re going to have to make shifts once you’re in the home and take on extra expenses.”

Freeing up that extra money in your monthly budget means you’ll have more available to pay off debt. And the more quickly you can pay off debt, the more quickly you can reduce your DTI to buy a home.

Increase Your Down Payment

When lenders calculate your DTI, they consider the impact of a mortgage loan on your finances and aim to keep your DTI with your mortgage under a certain level. According to Heck, you can reduce your DTI when you own a home by putting down a larger down payment, which will result in lower mortgage payments each month.

“If I’m getting into affordability, one of the best things to do is begin saving and either pay off existing balances as you save or save more to be able to put more down on your home, which would lower your DTI,” Heck says. “Those are both longer-term solutions, but that’s the true best approach to affordability.”