debt to income ratio

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

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%!

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Jump to DTI topics:

– Front-End and Back-End Debt-to-Income Ratios
– Max DTI for Conforming Loans
– Max DTI Ratio for FHA Loans
– Max DTI Ratio for VA Loans
– Max DTI Ratio for USDA Loans
– How to Calculate Your DTI Ratio
– What’s Included in the Debt-to-Income Ratio
– What’s Not Included in Your DTI
– What Is a Good Debt-to-Income Ratio?
– Stated Income to Avoid Debt-to-Income Ratio Problems
– Qualifying Rate for Debt-to-Income Ratio

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

  • Annual gross income (as reported on your tax returns/W-2 form): $120,000
  • Monthly gross income: $10,000
  • Monthly liabilities: $3,500
  • 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

  • There are actually two DTI ratios
  • One for the front-end (your proposed housing payment)
  • And another for the back-end (that includes all monthly debts)
  • Some lenders may require you to stay below both limits

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%.

Some 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)

  • Historic max is 28/36
  • Fannie and Freddie allow up to 43% DTI
  • But may go as high as 45-50% with compensating factors
  • And only 36% if it’s a manual underwrite

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.

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Max DTI Ratio for FHA Loans

  • General guideline is max ratios of 31/43
  • Though it can potentially be much higher
  • Based on the findings from an automated underwrite
  • Potentially as high as 55% (or even higher case-by-case)

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, such as below 620, a key credit score cutoff.

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, a minimal housing expense increase (no payment shock), and so on. Yet another reason to build credit and save up money 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

  • VA states 41% is max acceptable DTI
  • And 41% max without compensating factors is likely the limit
  • Possible to get approved with DTI between 41-50% with compensating factors
  • Or even higher in certain cases with exception

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

  • Generally set at 29/41 max
  • But automated underwriting may allow higher limits
  • Such as 32/44 max with compensating factors
  • And minimum credit cores of 680

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. If the loan is manually underwritten, the limits may be exceeded if loan is eligible for a debt ratio waiver.

Long story short, if you have a credit score of 680 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. But they’re still pretty strict.

How to Calculate Your DTI Ratio

  • Take your gross monthly income
  • And divide it by your proposed housing payment
  • And then your proposed housing payment and monthly liabilities
  • To get both debt ratios

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.

For that proposed housing payment, you can use my mortgage payment calculator to get the P&I payment. Then gather the insurance, taxes, and other costs from each source for an accurate estimate.

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.

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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 included in the debt-to-income ratio:

  • credit card payments
  • student loans
  • auto loan/leases
  • personal loans
  • alimony
  • child support
  • 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.

What’s Not Included in Your DTI

  • Car insurance premiums
  • Health insurance premiums
  • Cell phone bills
  • Cable bills
  • Gardening bills
  • Pool cleaning bills
  • Maid service and so on

At the same time, a lot of items aren’t included in your debt-to-income ratio. Examples include car insurance, health insurance, and various monthly expenses like cell phone bills and cable bills.

Additionally, stuff like a monthly pool cleaning bill or gardening bill likely won’t be included.

This isn’t a sure thing, but generally this type of stuff isn’t included in your debt-to-income ratio, though it might already be factored in because the DTI limits assume you have these other expenses.

That’s why lenders don’t allow DTI ratios up to 100% – there’s a big buffer to account for these everyday expenses we all incur.

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?

  • The lower the better
  • Which is the opposite of credit scoring
  • But as long as you’re below the max
  • It shouldn’t affect your home loan application

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

If you’re weighing the rent vs buy question and/or looking at properties to purchase, you should definitely know your DTI ratio well in advance to fine-tune your search.

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.

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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

  • For those who have trouble meeting DTI ratio requirements
  • A stated income loan could come in handy
  • But expect a higher interest rate as a result
  • And be prepared to document a significant amount of assets

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

  • Pay attention to the qualifying rate used by the lender
  • Which could differ from the note rate on the loan
  • If you apply for an adjustable-rate mortgage
  • You might be required to qualify at a higher interest rate to account for future rate adjustments

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. I also have a web-based mortgage affordability calculator that may help.

Read more: Do I qualify for a mortgage?

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