Debt-to-Income Ratio

The “debt-to-income ratio“, or “DTI ratio” as it’s known in the industry, is the way a bank or lender determines what you can afford in the way of a mortgage payment. By dividing all of your monthly liabilities by your gross monthly income, they come up with a percentage. This figure is known as your DTI, and must fall under a certain percent in order to qualify for a mortgage.

The maximum debt-to-income ratio will vary by mortgage lender, loan program, and investor, but the number generally ranges between 40-50%.

Update: Thanks to the new Qualified Mortgage rule, most mortgages have a maximum back-end DTI ratio of 43%. There is a temporary exemption for many loans, but a lot of lenders still want this number to be under 43%!

Let’s look at a basic example of debt-to-income ratio:

$120,000 annual gross income as reported on your tax returns/pay stubs

  • Monthly liabilities: $3,500
  • Monthly gross income: $10,000
  • 35% debt-to-income ratio

In this example, your debt-to-income ratio would be 35%. However, the debt-to-income ratio goes into greater detail and comes up with two separate percentages, one for all of your monthly liabilities versus income (back-end DTI ratio), and one for just your monthly housing payment (including taxes and insurance) versus income (front-end DTI ratio).

Front-End and Back-End Debt-to-Income Ratios

So in the above example, if your monthly housing payment makes up $2,000 of your $3,500 in monthly liabilities, your front-end DTI ratio would be 20%, and your back-end DTI ratio would be 35%. Many banks and lenders require both numbers to fall under a certain percentage, though the back-end DTI ratio is more important.

You may see a debt-to-income requirement of say 30/45.  Using the example from above, your front-end DTI ratio of 20% would be 10% below the 30% limit, and your back-end DTI ratio of 35% would also have 10% clearance, allowing you to qualify for the loan program, at least as far as income is concerned.

Max DTI Ratio for FHA Loans

The max DTI for FHA loans depends on both the lender and if it’s automatically or manually underwritten.  Some lenders will allow whatever the AUS (Automated Underwriting System) allows, though some lenders have overlays that limit the DTI to a certain number. These limits can also be reduced if your credit score is below a certain threshold.

For manually underwritten loans, the max debt ratios are 31/43. However, for borrowers who qualify under the FHA’s Energy Efficient Homes (EEH), “stretch ratios” of 33/45 are used.

These limits can be even higher if the borrower has compensating factors, such as a large down payment, accumulated savings, solid credit history, potential for increased earnings, and so on.

To sum it up, if you can prove to the lender that you’re a stronger borrower than your high DTI ratio lets on, you might be able to get away with it. Just note that this risk appetite will vary by lender.

Also note that mortgage insurance premiums are included in these figures.

Max DTI Ratio for VA Loans

For VA loans, the same automated/manual UW rules apply.  If you get an AUS approval, the maximum DTI ratio can be quite high.

However, if it’s manually underwritten then the maximum debt-to-income ratio is 41% (back-end).  There is no front-end requirement for VA loans.  Again, as with FHA loans, if you have compensating factors and the lender allows it, you can exceed the 41% threshold.

Specifically, if your residual income is 120% of the acceptable limit for your geography, the 41% DTI limit can be exceeded, so long as the lender gives you the go-ahead.

In other words, most of these limits aren’t set in stone, assuming you’re a sound borrower otherwise.

Max DTI Ratio for USDA Loans

For USDA loans, the max DTI ratios are set at 29/41.  However, if the loan is approved via the Guaranteed Underwriting System (GUS), these ratios can be exceeded somewhat, similar to FHA/VA loans.

Long story short, if you have a credit score of 660 or higher, solid employment history, and the potential for increased earnings in the future, you may get approved for a USDA loan with higher qualifying ratios.

How to Calculate Your DTI Ratio

If you’d like to figure out your debt-to-income ratio, simply take your average gross annual income based on your last two tax returns and divide it by 12. Then add up all your monthly liabilities and divide that total by your monthly income and voila. Keep in mind that you’ll need a free credit report to accurately see what all your monthly payments are.

The credit report will show you what your minimum or monthly payment is for each tradeline, which makes it simple to add them up. Some banks and lenders allow installment credit cards such as those issued by American Express to be excluded from the debt-to-income ratio as they often account for thousands of dollars a month, and likely get paid off in full monthly.

The debt-to-income ratio is a great way to find out how much house you can afford, as well as the maximum mortgage payment you qualify for. Simply add up all your liabilities and your proposed mortgage payment plus taxes and insurance to see what type of loan you can take out.

Stated Income to Avoid Debt-to-Income Ratio Problems

Most mortgage brokers that work with potential homeowners will avoid full documentation loans if they feel the borrower won’t qualify for the loan based on their gross income alone. For this reason, banks and lenders offer reduced documentation loans such as SIVA (Stated income, verified assets) loans, and No Ratio (no income, verified assets) loans.

Many people think reduced-doc loans are usually just stretching the truth, but they can also come in handy for borrowers who have increased their gross income recently, or those with complicated tax schedules, usually self-employed borrowers.

Qualifying Rate for Debt-to-Income Ratio

One important thing to keep in mind is the qualifying rate banks and lenders use to come up with your debt-to-income ratio. Many borrowers may think that their start rate or minimum payment is their qualifying rate, but most banks and lenders will always qualify the borrower at a higher rate to ensure the borrower can handle a larger amount of debt.

For example, a borrower may be on a negative-amortization loan program with a monthly payment of only $1,000, but their interest-only payment is actually quite higher, at say $2,500.

For a bank or lender to effectively gauge the borrower’s ability to handle debt, especially once the minimum payment is no longer available for the borrower, the lender must qualify the borrower at the higher of the two payments. This gives the lender security and prevents under-qualified borrowers from getting their hands on mortgages they can’t really afford.

Borrowers should also note that most debt cannot be paid off to qualify. If you have debt on credit cards or other revolving accounts and plan to pay them off with your new loan, their monthly payments will still be factored into your DTI. This prevents a borrower from refinancing their current mortgage or buying a new home and piling all their outstanding debt on top of the mortgage, just to rack up more debt on those cards a month later.

It also allows the bank or lender to gain a true measure of a borrower’s ability to handle debt. However, lenders will usually allow borrowers to payoff installment debt to qualify so long as they have sufficient, verified assets.

Download my Excel Debt-to-Income Ratio calculator below to figure out what you can afford: Debt-to-Income Ratio Calculator

Read more: Do I qualify for a mortgage?


10 Comments

  1. Kyle September 24, 2013 at 10:08 pm -

    Are lenders allowed to charge more for higher DTI ratios?

  2. Colin Robertson September 25, 2013 at 9:52 am -

    Yes, certain lenders may add adjustments to fee for DTI ratios between a certain percent, or above a certain percent. So if your DTI is above 50%, they might charge .50% as an adjustment to account for what they see as higher risk. And if your DTI is between say 45.01-50%, they might charge something like .25%.

  3. Evangeline February 9, 2014 at 5:39 pm -

    So if they charge fees for a higher DTI, is the mortgage rate higher as a result? Thanks.

  4. Colin Robertson February 10, 2014 at 12:17 pm -

    It depends, if the fees are enough to bump your rate at least an .125 higher, then yes. But you might just have to pay more in closing costs to get the same rate, all else being equal.

  5. Curtis February 22, 2014 at 4:12 pm -

    I’m considering making an offer on a home this spring. What steps can I take to lower my debt to income ratio over the next couple months?

  6. Anna February 23, 2014 at 3:51 pm -

    Are deferred student loan payments included in the DTI ratio for a mortgage? I’m wondering because I don’t need to start paying back my loan until 2015.

  7. Colin Robertson February 24, 2014 at 10:30 am -

    Curtis,

    Basically reducing your outstanding debt is the name of the game if you want to lower your DTI. That means paying down credit card balances, auto loans, etc, and avoiding opening new lines of credit. The less you owe, the smaller your monthly obligations will be. It could also boost your credit score. Just be sure not to deplete your assets in the process.

  8. Colin Robertson February 25, 2014 at 3:50 pm -

    For conventional loans, deferred student loan payments must be included in the DTI. However, for FHA/VA lending, student loans deferred more than a year (12 months) after loan closing can be omitted from the DTI calculation.

  9. Margaret September 1, 2014 at 6:09 am -

    I have approached the refi process over the past six months several times to no avail. I have been turned down because my dti 48-50%. I am on a fixed income and retired. I desperately need to refi and believe I can managed the extra $200-300 a month vs. the debt repayment of $1000 I have now. Who will help me refi?

  10. Colin Robertson September 2, 2014 at 11:38 am -

    Margaret,

    Have you tried brokers or just individual banks? A broker will be able to shop you with a slew of lenders at once to find someone that specializes in higher DTI and fixed income.

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