Your debt-to-income ratio is used by lenders to determine how much a borrower qualifies for.
Lenders also use your debt-to-income ratio to assess risk.
The higher your DTI ratio, the more of a risk the loan is.
This article takes an in-depth look at debt-to-income ratios, what it is, how to calculate it, and the maximum ratio you can have for a mortgage.
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What is a Debt-To-Income Ratio?
Your debt-to-income ratio is the amount of your income that goes towards your monthly debt obligations.
For example, if your monthly income is $5,000 and you have a car payment for $300 and a $200 student loan payment and your estimated mortgage payment is $1,000 a month for a total of $1500 in monthly debt payment obligations, your debt-to-income (DTI ratio) is 30%.
Debt-to-Income Ratio Needed for a Mortgage
Typically a mortgage lender will want a back-end debt-to-income ratio of 36% after figuring in your monthly mortgage payment. However, most mortgage loans will allow up to a 43% DTI ratio.
An FHA loan or VA loan will allow you to have a higher DTI ratio than a conventional mortgage, sometimes up to 50 percent.
Max DTI Ratio
115% of AMI
5% - 20%
80% of AMI
How to Calculate Your Debt-To-Income Ratio
To calculate your debt to income ratio, you will take your total monthly debt payments.
This includes credit card minimum payments, student debt loans and other personal loans, auto loans, and your mortgage payment.
You will then divide your total monthly payments by your gross monthly income, your income before taxes.
If your total monthly debt, including your mortgage payment, is $2,000, you will enter it on a calculator.
Then you will divide your monthly payments by your gross income. Let’s say your income is $5,000 before taxes.
Divide by $5,000
This gives you your debt-to-income ratio, which is 40%.
Front-End and Back-End Debt-to-Income Ratios
- Front-end DTI ratio – The front-end ratio is your debt ratio vs. your monthly income before your mortgage payment is added to your debt payments.
- Back-end DTI ratio – The back-end ratio is the ratio of your estimated monthly mortgage payment vs. your monthly gross income and does not include other debt obligations.
Costs Included in Housing Expenses
When factoring your DTI ratio, you will need to include a couple of expenses into the monthly payment.
- Principle and Interest
- Homeowner insurance
- Property taxes
Homeowner association dues are not factored into your housing expense. Insurance and property taxes are included in your monthly payment and put into an escrow account to be paid annually.
Your Credit Score Affects the Maximum DTI Ratio
Lenders look at your credit score very heavily as a factor that determines risk. The higher your credit score, the lower risk you present, and the higher the DTI ratio the lender will accept. Because of this, you will want to make sure you’re maximizing your FICO scores.
A quick tip to increasing your credit rating is to lower your credit utilization ratio. Credit utilization is the amount of available credit you have used up on your open credit card accounts. You should work on paying down your credit card balances below 15% of your card’s credit limit.
Compensating Factors for a High DTI Ratio
Lenders can accept a higher DTI ratio if a borrower has compensating factors that reduce the overall risk. These factors will allow you to get away with a DTI ratio on the high side.
- Limited payment shock
- 5+ years with the same employer or in the same industry
- High income
- Large amount in savings
- Good credit
- 20% down payment
- A low debt-to-income ratio
- Residual Income
- Limited debt (credit cards, auto loan, etc.)