What Is Your Debt-to-Income Ratio and Why Does It Matter When Applying for a Mortgage?

Two people sitting on the ground looking stressed while surrounded by papers.

Your debt-to-income ratio is one of the most important factors lenders consider when deciding how big of a mortgage to approve you for. Find out what DTI ratio is and how to calculate it.

Two people sitting on the ground looking stressed while surrounded by papers.

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When you need a mortgage to buy a home, your mortgage lender is going to look at a number of different factors in order to determine whether or not to lend to you and for what amount that loan should be. Mortgage lenders want to be sure you're able to pay back what you borrow, so they focus on things such as your credit score and history of on-time payments.

Lenders also look at how much debt you have relative to your income, to make certain that you're not getting in over your head when it comes to your financial obligations. The measure of the percentage of your income you're using to repay your debts is called your debt-to-income ratio, or DTI for short.

Most lenders require your DTI to be below a certain level, or they either will be unwilling to lend to you or will charge you much higher interest for a loan due to the risk you appear to present.

What is debt-to-income ratio?

A debt-to-income ratio is a simple ratio measuring how much of your money has to go towards making payments on debt. You can calculate DTI by adding up the payments on the debts you owe and comparing that to what you earn.

Mortgage lenders use your pre-tax, or gross income, when calculating your debt-to-income ratio. They also consider only minimum required payments on your debt, even if you choose to pay more than the minimum on what you owe.

For example, let's say your income is $5,000 a month and these are your debts:

  • A $250 monthly car payment
  • A $50 monthly minimum payment on your credit card
  • A $125 monthly student loan payment
  • $800 in monthly housing costs

Your total monthly debt payments in this case would be $1,225. Divide this by your monthly income of $5,000 and you'll see that your debt-to-income ratio is 24.5%.

Front-end and back-end debt-to-income ratios

Many mortgage lenders consider two different debt-to-income ratios when they're deciding if they want to give you a mortgage loan and deciding how much to lend. The two ratios include:

  • The front-end ratio: The front-end ratio is the amount of your monthly income that will go to housing costs after you've purchased the home you're buying with the mortgage loan. It takes into account your property taxes; your insurance; your principal and interest on your mortgage loan; and any homeowner's association fees. You'll divide the total value of housing costs by your income to get the front-end ratio.
  • The back-end ratio : The back-end ratio considers your housing costs along with all of your other debt obligations. To calculate this, add up all of your financial obligations, including your housing costs, student loan payments, car payments, personal loans, credit card debts, and other outstanding loans.

Lenders generally consider both types of debt-to-income ratios; however, the back-end ratio is typically more important because it gives lenders a big-picture view of your finances.

If your housing costs will be a little bit high relative to your income but you have no other debt at all, a lender may be more willing to lend to you because your total financial obligations will still be manageable even with taking out a bigger mortgage loan.

What debt-to-income ratio do lenders want to see?

Typically, lenders want to see a front-end debt-to-income ratio of 28% and a back-end ratio of 36%. However, some conventional lenders will allow a back-end ratio of up to 43%. And, if you're able to obtain a loan through a program with government backing, such as an FHA loan, your back-end debt-to-income ratio could go as high as 50%.

The lower your debt-to-income ratio, the more likely it is that you'll qualify for a loan at a favorable interest rate, especially if you have other positive factors such as a good credit score.

How to improve your debt-to-income ratio

Unfortunately, many people have too much debt relative to their income to qualify for a mortgage loan. The problem for many is that student loan payments are high, which results in a debt-to-income ratio that's too high to obtain a loan to buy a home.

To improve your debt-to-income ratio, you could try to earn more so you have a higher income relative to your debt. You can and should also try to pay down debt aggressively before applying for a mortgage so you have less debt that counts in determining your monthly financial obligations. Buying a lower cost home could also help, as this could reduce your mortgage loan costs as well as costs for property taxes and insurance.

You should also make certain you have chosen the right student loan repayment plan and are working with a lender that considers your actual monthly payment amount when determining your debt-to-income ratio. For example, if you choose an income-based plan, you could lower your monthly payment to a capped percentage of your income.

By capping your payment, you could bring your debt-to-income ratio in line with what lenders expect to see before giving you a mortgage loan. However, you'd need to ensure the mortgage lender you're working with considers the actual amount you pay under your chosen plan, rather than basing your DTI calculation on the standard payment you'd make if you paid off your loan under the default 10-year repayment plan.

A good debt-to-income ratio is key to qualifying for a home mortgage

It's a good idea to know what your debt-to-income ratio is before you apply for a mortgage so you can make certain you're able to afford to borrow as much as you need for the home that you want to buy.

If you don't make enough to qualify, you'll need to scale down your expectations for the amount you can borrow or pay off your other debts first before applying for a home loan. Fortunately, calculating your DTI is easy: just add up what you owe and compare it to your income and you'll figure out this important number that's so crucial when you're applying for a mortgage loan.

Just be sure to do the math before you fall in love with a house you can't afford because your debt would be pushed too high if you bought it.

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