Debt-to-income ratio for mortgage explained

January 13, 2022 - 8 min read

What is a debt-to-income ratio?

Mortgage lenders use debt-to-income ratio, or DTI, to compare your monthly debt payments to your gross monthly income.

Your DTI ratio shows lenders whether you could afford to make the payments on a new mortgage loan. In other words, DTI measures the financial burden a mortgage would place on your household.

Here’s what you should know about DTI and how it relates to your mortgage qualification.

Verify your mortgage eligibility. Start here

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Simple definition: debt-to-income ratio (DTI)

Debt-to-income ratio (DTI) shows a person’s monthly debt obligations as a percentage of their gross monthly income.

For example, if your monthly pre-tax income is $5,000, and you have $2,000 worth of monthly debt payments, your DTI is 40 percent. Debts that count toward your DTI include things like minimum credit card payments, auto loans, student loans, and your mortgage.

Mortgage lenders calculate DTI for all purchase mortgages and for most refinance transactions.

Your DTI ratio can help answer the question, “How much home can I afford?

DTI does not indicate your willingness to make your monthly mortgage payment. It measures only the economic burden that the mortgage would put on your household.Most mortgage guidelines enforce a maximum DTI limit.

Maximum DTI by type of loan

Your lender’s maximum DTI limit will depend, partly, on the type of loan you choose:

  • Conventional loan: Up to 43% typically allowed (36% is ideal)
  • FHA loan: 43% typically allowed (50% is possible)
  • USDA loan: 41% is typical for most lenders
  • VA loan: 41% is typical for most lenders

These rules don’t always apply to all borrowers in the same way.

For example, even if your DTI meets your loan’s requirements, you won’t be guaranteed approval. Your credit score, down payment amount, or income could still undermine your eligibility.

And it works the other way around, too: Some borrowers whose DTI ratios come in a little too high may still qualify if they have excellent credit or can make a larger-than-required down payment.

Verify your mortgage eligibility. Start here

Calculating your debt-to-income ratio

DTI measures your debts as a percentage of your income. Here’s the formula:

  • Monthly debt obligations (divided by) Monthly income (times) 100 (equals) DTI

For someone who owes $2,000 in debt each month and earns $5,000 in wages, the equation would look like this:

  • $2,000 ÷ $5,000 x 100 = 40% DTI

To calculate your own DTI, you’ll need to know:

  • Which debts to include in your monthly debt obligations
  • How much of your income to count

It’s not always a simple equation for mortgage borrowers.

Calculating income for a mortgage approval

Mortgage lenders calculate income a little bit differently than you may expect. There’s more than just the “take-home” pay to consider, for example.

Lenders also perform special math for bonus income; give credit for certain itemized tax deductions; and apply specific guidelines to part-time work.

The simplest income calculations apply to W-2 employees who receive no bonus and make no itemized deductions.

For W-2 employees, the lender will typically look at your pay stubs and use the year-to-date average to determine your gross income and your monthly household income.

Complex income scenarios

If you receive bonus income, your lender will look for a two-year history and will average your annual bonus as a monthly figure to add to your mortgage application.

For self-employed borrowers and applicants who own more than 25% of a business, calculating income is a bit more involved.

To calculate income for a self-employed borrower, mortgage lenders will typically add the adjusted gross income as shown on the two most recent years’ federal tax returns, then add certain claimed depreciation to that bottom-line figure. Next, the sum will be divided by 24 months to find your monthly household income.

Income which is not shown on tax returns or not yet claimed cannot be used for mortgage qualification purposes.

In addition, all mortgage applicants are eligible to use regular, ongoing disbursements for purposes of padding their mortgage income. Pension disbursements and annuities may be claimed so long as they will continue for at least another 36 months, as can Social Security and disability payments from the federal government.

Non-taxable income may be used at 125% of its monthly value.

Verify your mortgage eligibility. Start here

Calculating debt for a mortgage approval

For most mortgage applicants, calculating debt is more complex than calculating income. Not all debt on a credit report should be included in your DTI, and some debt which is not listed on a credit report should be used.

Lenders split debts into two categories: front-end and back-end.

  • Front-end ratio: Includes debts that relate to housing expenses: your mortgage payment, property taxes, and homeowners insurance premiums, for example
  • Back-end ratio: Includes minimum payments to your credit card companies, car payments, and student loan payments as well as your total monthly housing payment

Finding your front-end DTI

Your front-end DTI shows your new home’s cost as a percentage of your monthly income.

To calculate your front-end debt, add your mortgage principal and interest payment to your other monthly housing costs.

These additional housing costs can include your:

  • Annual real estate tax bill (divided by 12 to show monthly payments)
  • Annual homeowner’s insurance premiums (divided by 12 to show monthly obligation)
  • Monthly dues paid to a homeowners association (HOA)
  • Any private mortgage insurance premium (or FHA Mortgage Insurance Premium) that’s added to your monthly mortgage payment

Finding your back-end DTI

To calculate your back-end DTI as a lender does, add up the following figures, where applicable:

  • Your total monthly housing payment (calculated above)
  • Monthly minimum credit card payments
  • Monthly car loan payments
  • Monthly personal loan payments
  • Monthly student loan payments
  • Monthly child support and/or alimony payments
  • Any other monthly payment which is not listed on your credit report

Note that several exceptions to this list apply. For example, if you have an auto loan or other payment with 10 or fewer payments remaining, the debt does not have to be included in your DTI calculation.

Student loans for which payments are deferred at least 12 months into the future can be omitted as well. However, you will need documentation to prove this.

Dividing the sum of these debts by your monthly gross income, then multiplying the answer by 100, will show your back-end DTI.

Verify your mortgage eligibility

Some common DTI examples

Now that you know how to calculate DTI, you can find ways to achieve a lower DTI before applying for a loan.

Lowering debts or increasing your income will lower your DTI which could help you qualify for a better mortgage loan.

Here are some examples of DTI in action:

Calculating a 25% DTI

  • Monthly Social Security Income (taken at 125%): $6,000
  • Monthly recurring debts: $500
  • Monthly housing payment: $1,000

Calculating a 40% DTI

  • Monthly W-2 income (pre-tax): $10,000
  • Monthly recurring debts: $1,500
  • Monthly housing payment: $2,500

Calculating a 45% DTI

  • Monthly self-employment income: $10,000
  • Monthly recurring debts: $2,000
  • Monthly housing payment: $2,500

What’s a good debt-to-income ratio?

Conventional loans often require home buyer DTIs of 43% or less.

In some cases, loan approvals are possible with DTIs of 45%, or even higher — especially with FHA loans. But mortgage applicants with high DTI ratios must show strength on some other aspect of their application.

This “other aspect” can include making a large down payment, showing an exceptionally-high credit score, or having large amounts of reserves in the bank or as investments.

Also, note that once a loan is approved and funded, lenders no longer track debt-to-income ratio. It’s a metric used strictly for loan approval purposes.

After qualifying for the loan, it’s up to you to make sure you can afford the payment by keeping your credit card debt and other obligations in check.

What DTI should I aim for?

As a rule of thumb, your DTI should range between 36% and 43% when you’re applying for a mortgage.

That said, a lower debt-to-income ratio is always better. The lower your debt-to-income ratio, the better mortgage rate you’ll get.

DTI is a key ingredient in home affordability for many borrowers: When a low DTI helps you avoid high-interest mortgage loans, you can afford a more expensive home.

Verify your mortgage eligibility

Loans which don’t use DTI for approval

Mortgage lenders use DTI to see whether homes are “affordable” for a U.S. home buyer. They verify income and debts as part of the process.

However, there are several high-profile mortgage programs which are more flexible about the DTI calculation. These include loan options from the FHA, the VA, and Fannie Mae and Freddie Mac.

The FHA Streamline Refinance

The FHA offers a refinance program called the FHA Streamline Refinance which specifically ignores DTI, even if it’s a high DTI that wouldn’t qualify for an FHA purchase loan.

Official FHA mortgage guidelines also waive income verification and credit scoring as part of the streamline refi process. Instead, the FHA looks to see that the homeowner has been making the home’s existing mortgage payments on time and without issue.

If the homeowner can show a perfect payment history dating back three months, the FHA assumes that the homeowner is earning enough to “pay the bills.”

The VA Interest Rate Reduction Refinance Loan (IRRRL)

The VA Interest Rate Reduction Refinance Loan (IRRRL) is another refinance program that waives traditional DTI rules.

Similar to the FHA Streamline Refinance, IRRRL guidelines require lenders to verify a strong mortgage payment history in lieu of collecting W-2s and pay stubs.

The “VA Streamline Refinance” is available only to military borrowers who already have a VA loan. Homeowners must also show there’s a benefit to refinancing their existing home loan — either in the form of a lower monthly payment; or a change from an ARM to a fixed-rate loan.

RefiNow and Refi Possible

Fannie Mae and Freddie Mac recently came out with new refinance programs to help lower-income home buyers.

Fannie Mae’s RefiNow and Freddie Mac’s Refi Possible program are both ultra-flexible about qualifying borrowers with a high DTI. With RefiNow, borrowers may even qualify with a debt-to-income ratio as high as 65%.

If you’re currently in an unaffordable mortgage but not sure you’d qualify to refinance due to a high DTI, ask your lender about these two programs.

Get today’s mortgage rates

Today’s average mortgage rates remain near all-time lows.

A lower DTI can help you lock in these historically low rates, which means you could save on housing costs for decades to come.

To see where you stand, you can get a free rate quote today.

Time to make a move? Let us find the right mortgage for you

Dan Green
Authored By: Dan Green
The Mortgage Reports contributor
Dan Green is an expert on topics of money and mortgage. With over 15 years writing for a consumer audience on personal finance topics, Dan has been featured in The Washington Post, MarketWatch, Bloomberg, and others.