Debt-to-income ratio: What is it and how does it affect a mortgage?

When you apply for a mortgage, your lender will analyze your financial situation to determine how much mortgage you can afford — or if you can afford a mortgage at all. Part of this involves calculating your debt-to-income (DTI) ratio, which is crucial in determining if you qualify for a home loan. 

If you’re wondering what your DTI ratio is, how to calculate it and how it affects a mortgage application, here’s what you should know. 

What is your debt-to-income ratio?

Your DTI ratio is a percentage measurement of your monthly debt payments relative to your total income. Mortgage lenders consider your DTI ratio in their loan decisions as it can help them predict whether you can afford a new monthly payment or not. 

A lower DTI ratio is typically preferred by lenders as it shows that your debt levels are manageable relative to your earnings. 

How to calculate your debt-to-income ratio

There are two types of DTI ratios that your mortgage lender might look at when considering your application: your front-end DTI ratio and your back-end DTI ratio. Here’s how to calculate them:

Front-end DTI ratio

Your front-end DTI ratio only considers your future housing-related expenses, including the mortgage payment as well as homeowners insurance, property taxes and homeowners association (HOA) dues (if applicable). 

For example, let’s say your monthly mortgage payment (including taxes and homeowners insurance) will be $2,000, and your gross monthly income is $10,000. To calculate your front-end DTI ratio, you’ll simply divide this rent payment by your gross income, which would result in a ratio of about 20%.

Most mortgage lenders don’t consider your front-end DTI ratio in their application process. However, there are some exceptions, such as if you apply for a loan backed by the Federal Housing Administration (FHA).

Back-end DTI ratio

Your back-end DTI ratio includes all of your monthly debt payments as well as your housing expenses. This is the main type of DTI ratio considered by lenders for most kinds of loans. 

To calculate it, you’ll first add up your total monthly payments, such as your future mortgage payment, loan and credit card payments, alimony, child support or other debts. Then divide your total by your gross monthly earnings. 

For example, let’s say your monthly debts are as follows:

• Future mortgage payment: $1,800.
• Credit card payments: $700.
• Student loan payments: $400.
• Auto loan payment: $350.

That’s a total of $3,250 in monthly expenses. If your monthly gross income is $7,500, your DTI ratio will be just over 43%. 

Now let’s say you repay one of your credit card balances, and your monthly payments decrease to $450. This would reduce your total monthly debt payments to $3,000, and as a result, your DTI would also decrease to 40%. 

Why your debt-to-income ratio matters

Mortgage lenders rely on your DTI ratio to help determine if your expenses are manageable relative to your income. This ratio can help them figure out if you can afford another monthly payment and what monthly payment amount will be reasonable for your budget. 

When you apply, your lender will comprehensively analyze your finances. This includes checking your credit as well as requesting tax returns, W-2s, bank statements and more. The information you share will then be used to calculate your DTI ratio. If your DTI ratio is too high by a lender’s standards, you likely won’t qualify for a home loan. 

Is there a good debt-to-income ratio for a mortgage?

Generally, a DTI ratio of 45% or below is considered acceptable if you meet certain credit score and down payment requirements, while a ratio of 36% or below is considered very good. 

There are also some mortgage lenders that accept DTI ratios as high as 50%, depending on the type of loan you apply for. However, keep in mind that a high DTI ratio can result in getting a less favorable interest rate on your mortgage. 

Ultimately, reducing your total debt or increasing your income could improve your likelihood of getting a home loan as well as help you qualify for a good interest rate.

Debt-to-income vs. debt-to-limit: What’s the difference?

While debt-to-income and debt-to-limit sound similar, there are important differences between the two. Lenders use your DTI ratio in loan decisions, and it measures your total monthly debt — including installment loans and revolving debt like credit cards — versus your monthly gross income. 

Your debt-to-limit ratio — also called your debt-to-credit or credit utilization ratio — measures your monthly revolving debt versus your total available credit. Popular credit scoring models like FICO and VantageScore take this ratio into account when calculating your credit scores. 

While mortgage lenders might also look at your debt-to-credit ratio, they’re more likely to consider your DTI ratio as it provides more comprehensive insight into your monthly spending.  

Struggling to pay off debt? Compare a payoff plan from the best debt management companies

Tips for improving your debt-to-income ratio

A DTI ratio at or below 36% can make it easier to get approved for a home loan and could help you qualify for lower rates. If you suspect your DTI ratio is too high to qualify for a mortgage, here are some tips that might help you reduce it:

• Pay down your debts. One of the best ways to lower your DTI ratio is to pay down existing debt. Not only will this make it easier to get approved for a home loan, but it will also lighten your debt burden overall. 
• Reduce your interest rates. If you can qualify to reduce your interest rate on an existing credit card or loan, it could also result in a lower monthly payment. Consider negotiating with your credit card issuers or lenders to see if they’d be willing to lower your rates. 
• Consolidate your debt. Another possible way to reduce your monthly payment amounts is to consolidate your debt. For instance, say you have a high-interest credit card, and your payments are high because you’re carrying a balance. If you take out a debt consolidation loan with a lower rate to pay off your card, the monthly payment on your loan will likely be lower due to this better rate. Keep in mind that you’ll generally need good to excellent credit to qualify for the best rates on debt consolidation loans.
• Increase your income. Asking for a raise, picking up a part-time role or starting a side hustle you enjoy can all help you bring in more money each month, which can reduce your DTI ratio. 

Other strategies

If you’re struggling to qualify for a mortgage based on your DTI ratio, the problem could be that the resulting mortgage payment is simply too much for your budget. In this case, opting to buy a less expensive home could be a better option than trying to reduce your DTI ratio — though reducing your overall debt is generally a good thing to strive for, too.

You can also ask your mortgage lender for advice on what could help nudge your DTI ratio into a qualifying range. Since a mortgage loan officer is already looking at all of your financial statements, they could have good suggestions on what would be best to focus on to improve your application.

Frequently asked questions (FAQs)