What Is Your Debt-to-Income Ratio?

When you apply for a mortgage, your lender takes a deep dive into your financial situation to determine your eligibility. You might have a good credit score, stable income, and a history of paying your bills on time, but if your debt-to-income ratio (DTI) is too high, lenders may question your ability to take on a mortgage. That’s why it’s important to understand what DTI lenders are looking for before you start applying for home loans. 

How to Calculate Your Debt-to-Income Ratio 

First, figure out how much you (and any co-borrowers, if applicable) make each month. If your income is consistent, you can simply check your pay stubs from last month. However, if your earnings fluctuate from month to month, divide last year’s income by 12 to get an accurate monthly average. Remember to make your calculations using the full amount you receive before any tax withholdings, healthcare costs, or retirement plan contributions are taken out. 

Next, learn the difference between the two types of debt-to-income ratios. 

The Front-End Ratio 

Sometimes called the top ratio, housing ratio, or PITI ratio, the front-end ratio represents your housing payments as a percentage of your gross monthly income. PITI (principal, interest, taxes, and insurance) includes all your major housing costs — the principal on the loan you’re paying back, the interest on that loan, real estate taxes, and homeowner’s insurance. PITI also includes any additional insurance, homeowner’s association (HOA) fees, condo fees, and special assessments. 

To calculate your front-end ratio, add up your monthly housing expenses and divide that number by your gross monthly income. Finally, multiply the total by 100 to get a percentage. For example, if your housing expenses are $1,800 and your gross monthly income is $7,500, your front-end ratio is 24%. 

The Back-End Ratio 

Also known as the bottom ratio or total debt (TD) ratio, the back-end ratio shows what percentage of your income is needed to cover all your debts. This includes housing expenses as well as car loans, credit card payments, student loans, child support, alimony, and other debts. Living expenses, such as groceries and utilities, are not included. 

To determine your back-end ratio, add up all your monthly debts and divide this number by your gross monthly income. For instance, if you have $400 car payments, $250 student loan payments, and $300 credit card payments, that’s $950 per month. Combine that with your $1,800 housing costs, and you have $2,750 in total monthly debts. Divide that total by your $7,500 gross monthly income, and you’ll find that your back-end ratio is 37%. 

What Is a Good Debt-to-Income Ratio? 

Your front- and back-end ratios matter when applying for a mortgage because they can indicate your ability to keep up with payments. Lenders know that people with a low debt-to-income ratio are less likely to default on their loans, making them more eligible for a mortgage. 

For conventional home loans, lenders like to see a front-end ratio of 28% or lower. Then, the back-end ratio should be no higher than 36%. 

Someone with $7,500 in gross monthly income should pay no more than $2,100 in housing costs ($7,500 x 0.28 = $2,100). In the above example, earning a $7,500 income and having a $1,800 mortgage payment is well below the requirement.  

With that same income, the total debt should be no more than $2,700 per month ($7,500 x 0.36 = $2,700). The debts in the above example come in at $2,750, meaning the borrower may need to lower their debts or demonstrate their eligibility in other ways. 

What Debt-to-Income Ratio is Needed When Applying for Different Mortgages? 

While it’s good to aim for a DTI of 28/36, you may not be applying for a conventional home loan. Here are the debt-to-income ratio requirements for different types of mortgages: 

• FHA home loans: Front-end ratio – 31% | Back-end ratio – 43% 
• USDA home loans: Front-end ratio – 29% | Back-end ratio – 41% 
• VA home loans: No front-end ratio specified | Back-end ratio – 41% 
• Native American home loans: No front-end ratio specified | Back-end ratio – 41% 

What to Do if Your DTI is Too High 

In reality, some lenders might allow a DTI above the required limits, depending on the borrower’s credit score, lending profile, and other factors. If your DTI is too high, but you’re confident you can afford the mortgage, it may be helpful to get a co-signer. In the case of FHA loans, you can have a relative who doesn’t live with you co-sign your mortgage. This person must have sufficient income and good credit for co-signing to make a difference. 

Another option is to pay off as much debt as possible before applying for a mortgage. However, this can be challenging if you’re also trying to save up for a down payment and closing costs. 

If paying off debt isn’t feasible right now, be aware that lenders are more likely to extend a home loan to borrowers with a high DTI if they can demonstrate what the industry calls “compensating factors.” Here are some examples: 

• You have a significant amount of savings or cash reserves. 
• You have a strong job history and a high potential for increased future earnings. 

• You plan to make a sizable down payment. 
• You have recently and consistently paid higher housing payments than your anticipated mortgage.