Debt-to-Income Ratio (DTI): What It Is and How to Calculate It

debt to income ratio

The “debt-to-income ratio“, or “DTI ratio” as it’s known in the mortgage 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 (including the proposed housing payment) by your gross monthly income, they come up with a percentage. This key figure is known as your DTI, and must fall under a certain number 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%. However, 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 the debt-to-income ratio:

$120,000 annual gross income as reported on your tax returns/W-2 form

  • 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% ($3,500/$10,000). Pretty simple, right?

Well, before you think you’re done calculating your DTI, you should know that the debt-to-income ratio goes into greater detail and comes up with two separate percentages.

One for all of your monthly liabilities divided by your gross monthly income (back-end DTI ratio), and one for just your proposed monthly housing expense (including taxes and insurance) divided by income (front-end DTI ratio).

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

In the example above, if your proposed 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 since it considers all your monthly debts, and is thus more representative of the risk you present to the lender.

You may see a debt-to-income requirement of say 30/45. Using our same example, your front-end DTI ratio of 20% for the housing expense only 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.

*If you own other property with a mortgage, it should be included in the back-end DTI ratio because it’s not part of the new loan you are applying for.

Max DTI for Conforming Loans (Fannie Mae and Freddie Mac)

The classic, “rule of thumb” ratios are 28/36, meaning your front-end ratio shouldn’t exceed 28%, and your back-end ratio shouldn’t exceed 36%.

However, this measure is more conservative than what you might actually see in practice today. For example, back in the day many homeowners put down 20%. Today, the down payments are often just 3-10%, to give you some perspective.

But, Fannie Mae still does impose a max DTI of 36% for manually underwritten loans, though the majority of loans are approved via their automated underwriting system called Desktop Underwriter (DU).

And DU will allow DTIs up to 45%, and as high as 50% with compensating factors, such as plentiful assets, larger down payment, great credit, etc.

In other words, you can bend the rules a little bit if you’re a good borrower otherwise. But if you have bad credit and nothing in your savings account, don’t expect any favors in the DTI department.

For Freddie Mac, underwriters must include a written explanation that justifies exceeding the 28/36 ratios when files are manually underwritten. Like Fannie, the ratios may go higher if the file is approved via automated underwriting.

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, say 55%.

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. Yet another reason to build credit before applying for a mortgage!

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 mortgage 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 debt ratio 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 and enjoy higher DTI limits.

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 (months).

So if you made on average $100,000 gross (before taxes) each year for the past two years, that would equate to $8,333 per month in income.

Next, add up all your monthly liabilities and your proposed housing payment (including taxes, insurance, HOA if applicable) and divide that total by your monthly income and voila.

When I say liabilities, I mean all the minimum payments that appear on your credit report. Bills that don’t show up on your credit report generally aren’t counted toward your debt-to-income ratio because they aren’t credit-related and/or documented.

For example, health insurance premiums, a cell phone bill, cable bill, gardening bill, gym membership, or a pool service may not figure into your DTI. This is a good thing if you’re cutting it close.

Keep in mind that you’ll need a free credit report to accurately see what all your monthly payments are. Fortunately, these are very easy to come by these days.

A credit report will show you what your minimum or monthly payment is for each tradeline listed, which makes it simple to add them up.

Typical monthly costs that are included in the debt-to-income ratio:

  • credit card payments
  • student loans
  • auto loan/leases
  • personal loans
  • mortgage loans and home equity loans on other properties you own
  • housing costs on subject property including homeowners insurance, mortgage insurance, property tax, HOA dues

All the above count against your income, so if you can eliminate or reduce these debts, your income go will further in terms of what you’re able to afford.

When it comes to plastic, the minimum credit card payment listed on your credit report will be considered. All the more reason to apply for a mortgage when all your credit cards are paid off, with no new charges, if practical.

Some banks and lenders allow installment (charge) 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.

Anyway, let’s assume you’ve got $1,000 in monthly liabilities on your credit report thanks to some credit cards and a car loan, and a proposed housing payment of $2,000, including insurance and taxes. If we combine those two figures, we come up with $3,000.

Now simply take that $3,000 in monthly debt and divide it by our original monthly income figure of $8,333. That gives us a debt to income ratio of 36%. This number is below the maximum and should be sufficient to get a mortgage, as long as you qualify otherwise.

By the way, the front-end debt to income ratio would be 24%, which is $2,000 divided by $8,333.

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.

Obviously, you’ll need to take a gander at current mortgage rates and then plug your loan amount into a mortgage calculator to find that proposed payment, and then do your best to ballpark insurance and taxes.

If you want extra credit, get insurance quotes early on and visit your tax assessor’s website to fine-tune those numbers.

You’ll probably want to err on the side of caution and round everything up, including the mortgage rate, to ensure you’re not calculating your DTI too liberally.

What Is a Good Debt-to-Income Ratio?

Unlike a credit score, where higher is better, a good debt-to-income ratio for a mortgage is one that is low.

But like credit scores, which stop benefiting you at a certain level, there’s a point where it doesn’t matter how low your DTI is either.

Really, you just want/need it to be below the key thresholds listed above. As long as you’re below those numbers, you’re “good.”

So just focus on being below the maximum ratios and you’ll have a good shot at getting approved for a mortgage, assuming you meet the other qualifying criteria for things like credit history, assets, and so forth.

As noted, it’s nice to have a buffer in case mortgage rates increase from application to funding, or if any monthly debt was left out or underestimated in error.

Tip: If your DTI is too high, you might be able to lower it by putting more money down and/or buying down your interest rate, both of which will reduce the monthly payment. So there are always options if you take a wrong turn!

Stated Income to Avoid Debt-to-Income Ratio Problems

It’s also possible to go the stated income route if you feel you won’t qualify for the loan based on your gross income alone. But unlike the liar’s loans of the early 2000s, today’s stated loans rely on a healthy stable of assets to offset any income shortcomings.

One such example is a bank statement loan, which calculates income by using bank deposit history over a certain period of time. So you still need to have lots of money in the bank to get a mortgage.

If you find yourself in this situation, mortgage brokers can be helpful because they work with a variety of banks and lenders, including specialty lenders. The big retail banks may not be able to accommodate you.

Before the crisis, pretty much every bank and lender offer reduced documentation loans such as SIVA (stated income, verified assets) loans and No Ratio loans (no income, verified assets), and very few borrowers actually documented their income. Those days have come and gone.

Many people think reduced-doc loans are 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 mortgage 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 interest rate to ensure the borrower can handle a larger amount of debt in the future assuming payments rise.

For example, a borrower may be in an adjustable-rate mortgage with a monthly payment of only $1,000, but their fully-indexed payment could quite a bit higher, say $1,500, after the fixed period ends.

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, the monthly payments will likely still be factored into your DTI.

This prevents a borrower from refinancing their 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 pay off installment debt to qualify so long as they have sufficient, verified assets.

But as mentioned earlier, it’s better to apply for a mortgage when you don’t have a lot of outstanding debt. Aside from be able to qualify for a larger loan amount, your credit scores will probably be higher as a result, which can land you a lower rate!

You can download my Excel-based Debt-to-Income Ratio calculator below to figure out what you can afford: Debt-to-Income Ratio Calculator. Or check out similar loan calculators on the web if you need help with your DTI calculation.

Read more: Do I qualify for a mortgage?



111 Comments

  1. Colin Robertson December 25, 2017 at 3:09 pm -

    CJ,

    Yes, you would be considered a first-time buyer, but that might not be necessary. As it stands, you’ll likely need to look at the FHA or USDA because of the low credit scores and high DTI. Ideally, you could work on upping your scores to 620+ to also qualify for a Fannie/Freddie loan as well. That would probably be my first step personally, but if time is of the essence, you might not have that luxury. The DTI is tougher but there are exceptions if you exceed 43% with compensating factors. And having down payment funds and some assets to spare is always helpful. The FHA only requires 3.5% down for 580+ credit scores and the USDA has no down payment requirement, but for the latter the home will need to be located in a rural area. You can also look at your state housing finance agency for even more flexible programs that are based on those already mentioned. Do some more homework and see if you get your scores up in the meantime. Good luck!

  2. CJ December 22, 2017 at 3:30 pm -

    My husband and I are looking at buying a house. I’ve never owned a home. He hasn’t owned a house in almost 20 years. So we will qualify for first time homebuyer programs. Our middle scores are both at 600 and our DTI is around 54%. We moved states a little over a year ago for better jobs, but since we haven’t had current jobs for at least 2 years, they can’t include our mandatory overtime or my monthly bonuses that average $350/month. Otherwise our DTI would be around 47%. What types of loans do you think would be best to look into? I don’t want to have every company under the sun running our credit and putting more hard inquiries on our credit (literally the worst thing on our credit report is how many hard inquiries we have, hence why I want to avoid it as much as possible) I want to stick with only the most likely options. I know some inquiries will fall off our credit and we’ll have some loans paid off within the year, plus I get raises every 6 months, so our credit scores and DTI will both be a lot better within a year, however our current rental is not safe for our kids (and our landlords won’t fix anything), and due to Hurricane Harvey, there are very few safe rentals in this area that wouldn’t be charging an arm and a leg to rent due to the high demand, low supply ratio. That’s why we don’t want to wait another year to buy and why we’re anxious to find a lender who can work with us now. We even found a house that would be within our budget and is listed at $25,000 below appraised value. Our scores and DTI are what’s holding us back… And with 4 kids, we wouldn’t be able to put more than 5% down, and even that would be a hard stretch….

  3. edwardo September 21, 2017 at 1:35 pm -

    ok I understand. lets say we refinance the card and the payment comes down to $380. having the $380 a month and no other debts. with only 1% down payment (1st time H. owner) and the lowest today’s rate, making 50k. by your experience, what would be the max mortgage that I can get?

  4. Colin Robertson September 20, 2017 at 12:46 pm -

    Edwardo,

    It will depend on the down payment, the interest rate she receives on her loan at that time (they could be higher), and if the lender treats the car loan as your debt since you’ve been paying it (and can document that fact). You may want to get a pre-approval to address any concerns now so you’re prepared come next March. Good luck.

  5. edwardo September 19, 2017 at 9:25 am -

    Hi Colin,
    I need advice on my situation. My wife is planning to buy a house around 3/01/2018. Here is the situation; the house that she wants is about 250k in Virginia beach, VA. Her income is 50k a year, no debts except a car loan for $520 a month, her credit score is around 740. She has a saving of 20k but we planning on a minimum down payment. She wants to use the first time homebuyer program available in our area. I know 50k for a 250k mortgage sounds too high. The car loan is under her name but I use the car and I pay the loan since day one so that will be an issue for sure. My question is do you think she can get a 250K loan on her self according to the profile that I gave you?

    Right now she is just saving as much as possible for next year so she can have at least 20 or 25k by 3/1/2018 and paying all her bill on time.
    Now I know you are asking yourself why not to include myself on the loan or just transfer the car loan under my name, and the answer is that I recently file for chapter 13 but my wife is not included because we separated for a few months. I can afford the car loan and I will be paying it. also all expenses for our kids comes out of my paycheck, in other words she will only have the mortgage responsibility.

  6. Colin Robertson July 14, 2017 at 12:47 pm -

    Jonathan,

    It really depends how the lender interprets it all, but generally DTI only factors in liabilities found on a credit report. So groceries and utility bills are typically not part of the DTI because they’re factored in elsewhere, like via credit card bills and so forth that do show up on credit reports with associated minimum payments. Not sure on the P&L bit, you’ll have to ask your lender how they calculate it specifically.

  7. Jonathan Traister July 12, 2017 at 4:38 pm -

    Hi Colin, i am preparing my figures (Profit and loss/ self employed) to do a modification on my loan. I am a bit confused on two things:
    1: The 55% of debt to gross income requirement. My main question is, does that 55% of Gross income to debt ratio , include all expenses like groceries, internet, phone etc… ​+ modified loan payment, OR JUST modified loan payment, + any revolving credit cards & HOA fees.?
    2. If my profit and loss gave me my net monthly profit, wil they multiply that income by something to reduce ofr taxes or anything else?
    Please share your knowledge on this one and thank you.!

  8. Colin Robertson May 20, 2017 at 7:13 am -

    Scott,

    Lenders take gross income, so taxes wouldn’t factor in anyway.

  9. Scott Gabriel May 19, 2017 at 10:29 pm -

    My income is all tax FREE it dont make Lot of sense to me that the same dti ratios should apply

  10. Colin Robertson May 1, 2017 at 11:50 am -

    Lanay,

    I wrote about this topic elsewhere on the site. In any case, you may want to get a pre-approval to see if you can qualify in all the scenarios or just certain ones, then go from there. Good luck!

  11. lanay foster May 1, 2017 at 10:15 am -

    Hello Collin,

    I am looking to purchase a home soon. However, I have students loans which I am on a $0 payment IBR plan. I was told by one lender that they will use 1% of the total student loan debt. I was also told by another lender that if I started to make payments on my own that the underwriter will use that amount as payments. I am not sure what to do.?

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