What is debt-to-income ratio?
Your debt-to-income ratio is the amount of monthly recurring debt payments compared to your gross monthly income.
For instance, let’s say that your gross monthly income is $5,000. You have a total of $2,000 of recurring debt obligations, which include a car loan, rent, and a credit card balance.
To calculate your DTI ratio, you can divide your minimum payment and debts ($2,000) by your gross monthly income ($5,000). In this scenario, the result would be 0.40, or 40%. You want your DTI to be 50% or less because this provides enough financial leeway to cover other expenses.
Not all your monthly expenses are used to calculate DTI. Lenders will only examine certain bills and obligations when assessing your debt-to-income ratio. These include rent or mortgage payments, car loans, student loans, credit card debts, or other monthly debt payments. They also include recurring obligations like child support and alimony.
Your DTI does not include miscellaneous expenses like utility bills, home repairs, groceries, daycare, commuting expenses, health care/insurance, or car insurance.
How to calculate debt-to-income ratio for a mortgage
Front-end and back-end DTI
Your debt-to-income ratio can be divided into two subtypes: front-end and back-end DTI.
Front-end debt-to-income ratio (housing expenses)
Front-end DTI is the ratio between your gross income and your current or projected housing expenses. This figure will include your base mortgage payment, property taxes, mortgage insurance, homeowners’ insurance, and homeowners’ association dues when applicable.
When evaluating your creditworthiness, lenders will assess your total DTI and your front-end DTI. Generally, lenders want your front-end DTI to be under 35%. However, some loan programs and lenders have slightly different thresholds.
Back-end debt-to-income ratio (debts)
Back-end DTI is generally larger than front-end DTI and represents the total recurring debts that you owe compared to your gross monthly income. The back-end DTI includes the front-end expenses (mortgage payment, property taxes, mortgage insurance, homeowners’ insurance, and homeowners’ association dues) and the recurring obligations we spoke of previously (car loans, student loans, credit card debt, child support, and alimony).
Breaking down DTI into front-end and back-end can help you better understand which financial obligations are making the biggest impact on your creditworthiness.
Tips to lower your debt-to-income ratio
If you’ll be applying for a mortgage soon and want to know how to lower debt-to-income ratio, remember these tips and tricks:
Getting a loan with a high debt-to-income ratio
While most lenders want your DTI to be less than 50%, there are instances where you may qualify for a loan with a high debt-to-income ratio. You may still be able to qualify for a type of home loan by working with a local loan officer.
For example, if you are self-employed, your W2s might not accurately reflect your true income. As a result, your DTI will appear unusually high even if you are in good financial health. A Non-QM loan solution may best fit your unique financial situation.
