A debt-to-income ratio (DTI) is a fundamental financial metric that lenders use to evaluate a potential borrower’s ability to make monthly payments. Essentially: How likely are you to repay your loan in full? Your debt-to-income ratio is the total of all of your monthly debt payments divided by your gross monthly income. Your DTI is used to assess your financial health and determine if you’re in a position to take on something as large as a mortgage and its associated payments.

Widely known as the housing ratio, the front-end DTI represents how much of your pre-tax monthly income would go towards a mortgage payment and other housing expenses. None of your other debt will be considered in the front-end DTI calculation. While every lender sets their own limits, generally, they prefer a front-end DTI that is no higher than 28%. The exact percent accepted will depend on the lender, the type of mortgage, and the borrower’s credit score and down payment.

Typically, the default term when referring to a mortgage, your back-end DTI refers to how much of your total income is needed to accommodate your current recurring monthly debt payments in addition to a potential mortgage. Lenders are often most interested in back-end DTI and like to see it at 36% or lower.

Your DTI is one of the main factors that decide whether you get a loan and how much it is. According to the Consumer Financial Protection Bureau, 43% is generally the highest DTI ratio that someone can have and still get a qualified mortgage. Lenders will always advise you to maintain a DTI that is lower than 43%, since your ratio is a pre-tax calculation and does not represent what you actually take home each month. 

There are still lending options for those who do not meet the 43% threshold, though they are less stable than a qualified mortgage and may have some risky loan features: an interest-only period, negative amortization, and balloon payments. For example, Fannie Mae lends to people who have up to a 50% DTI with compensating factors. Factors like offering a larger down payment or a great credit score.

Calculating your DTI doesn’t have to be as daunting as it may sound. The first step in figuring out your back-end DTI is to make a list of all of your recurring debt payments. Then, add them together to find your total monthly debt. When assessing your monthly payments, you should only list the minimum required payment for each type, even if you pay more than that.

Let’s say you have a $1,500 mortgage, $450 auto loan and $650 in personal and student loans. Your monthly debt total is $2,600. ($1,500 + $450 + $650 = $2,600)

Payments to include in your monthly debt total
Payments that should be excluded from your monthly debt total
Auto loans
Car insurance
Credit cards
Student loans
Personal loans
Cell phone
Child support payments
Health care bills
Co-signed loans
Utility payments (water, electricity, gas, etc.)
Alimony payments
Entertainment and lifestyle expenses

Step 2

The next step in calculating your DTI is to determine your gross income. Make sure this number is put on a monthly scale before taxes and other deductions. When assessing your gross monthly income, you should include these things (if applicable):

  • Wages, salary and tips
  • Monthly pension allotment 
  • Social security
  • Disability 
  • Alimony or child support
  • Investments that yield income
  • Any freelancing income

For the sake of this exercise, you’ve found that your monthly debt is $2,600. Now it’s time to find your total monthly income. If you make $5,000 in wages and $1,000 in freelancing income, your total monthly income is $6,000. ($5,000 + $1,000 = $6,000)

Step 3

Divide the total of your monthly debt obligations by your gross monthly income. The percentage result is your DTI. Think about your DTI ratio as the amount of your monthly income that is already sectioned off to make minimum payments on your loans. This ratio does not include additional expenses like cable, internet, phone, food or health insurance, meaning it only shows one facet of your financial condition. 

In this example, your total monthly debt payments is $2,600 and your monthly income is $6,000. Divide your total monthly debt by your monthly income to find your debt to income ratio of 43%. ($2,600 / $6,000 = .433)

What Your Debt-to-Income Ratio Means

Your DTI directly affects lending decisions and the options you have. A lower DTI means you are a low-risk borrower. You’ve managed your current debt well and your income will be able to cover an additional loan, you’ll have plenty of options. If you are on the higher side of acceptable DTI ratios, it means your budget may already be overextended and adding another loan would reduce the chances of consistent payments. This makes you a high-risk borrower and in the end limits what options you have. 

  • 35% or less: Viewed as the most favorable by lenders. You manage your budget effectively and probably still have money left over to save after you’ve paid all of your bills. Borrowers at this level are most equipped to handle an additional monthly payment. 
  • 36% to 42%: You still have options if your DTI is 36% to 42%, though you should consider taking steps to reduce debt. Monitor your DTI closely to ensure you don’t gradually take on unneeded expenses. 
  • 43% to 49%: In this range, your options begin to narrow. It’s suggested that borrowers begin to pay off their existing loans at a higher rate to be better prepared for future emergencies or expenses.  

50% or more: Immediate action to reduce debt is needed if your DTI falls within this range. When half of your income is going to various debt payments, you don’t have much left over. Borrowing options will be extremely limited.

How to Lower Your Ratio

Decrease your debt

Refinance or consolidate your debt

If your DTI is above the 43% rule, you have some work to do. While it may hinder your attempts to get a loan, not all hope is lost. The first thing you should do is work towards lowering your debt. Your DTI is based on the payments you make on your debts, not the total balance. So, refinancing your loans or consolidating multiple debts into a program with lower interest rates help decrease your monthly payments.

Create a budget and track your payments

Sit down and take a hard look at your finances. Where are you spending too much and what changes can you make? Make a budget for yourself and closely track your payments to ensure you aren’t spending outside of your means. If you are, consider where you can cut down and use that money to put towards extra payments. You should also avoid adding new debt with large purchases that will impact your credit, or opening any new credit lines prior to applying to a mortgage. 

Design a plan to pay down your balances

The most straightforward way to lower your DTI is to simply decrease your debt by paying it off. Of course, it sounds easier than it will be. Making extra payments or increasing the amount you pay each month will lower your debt total and allow you to pay off debts at a quicker rate. There are two widely used methods to effectively pay down your debt. 

  • Snowball method: This practice suggests that you aggressively pay off your smaller loans or debts while paying minimum payments on the more substantial ones.
  • Avalanche method: Also known as the ladder method, this practice recommends focusing the bulk of your money after all minimum payments on the debts with the highest interest rates. You work your way down, always paying the most on the highest interest debts. 

Increase your income

Increasing your income will directly impact your DTI. Though for most, this part is the hardest to do. Getting a pay raise at work will result in a drop in your ratio, though that can’t always happen overnight. That’s why increasing your income while working towards paying off your debt is your best option.

It’s not hard to see why having the lowest possible DTI is important. A high ratio lessens your ability to make big purchases, keeps you from getting the best interest rates and threatens your financial stability as a whole. If you find yourself in need of making changes, don’t forget to check in on your DTI from time to time as you take strides to improve your ratio and see what progress you’ve made.

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