Debt-to-income ratio, taxes, and insurance: How your DTI is calculated

January 12, 2021 - 7 min read

Does DTI include taxes and insurance?

Your debt-to-income ratio, or ‘DTI,’ is one of the key figures lenders use to decide how much house you can afford.

DTI measures your monthly income against your ongoing debts, including your mortgage, to figure out how large of a payment you can afford on your budget.

Since property taxes and homeowners insurance are included in your mortgage payment, they’re counted on your debt-to-income ratio, too. That means tax and insurance rates will impact your loan amount.

Here’s how to calculate DTI with taxes and insurance and figure our what you can really afford.

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How is DTI calculated?

Lenders want to be sure you can repay your mortgage debt. So they look closely at several financial details, including your debt-to-income (DTI) ratio.

DTI is calculated by adding up your monthly debt payments and dividing them by your gross (pre-tax) monthly income.

Debts that count toward your DTI include things like:

  • Home loan payments (including principal, interest, taxes, and insurance)
  • Credit card debt
  • Student loans
  • Auto loans
  • Personal loans
  • Child support
  • Alimony
  • Any other monthly payment for debt, even if it is not listed on your credit report

This shows what percentage of your income is taken up by existing debts, and how large of a mortgage payment you could reasonably afford on top of your current obligations.

Note that non-debt payments like gas, electric, and cell phone bills are not counted toward DTI.

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How taxes and insurance affect your DTI

“Property taxes and homeowners insurance are definitely part of the debt-to-income ratio calculation,” says Denise Panza, a senior mortgage banker with Total Mortgage. “As a matter of fact, they are a huge piece of the equation.”

Taxes and insurance are typically paid along with your mortgage principal and interest. As such, lenders will add the monthly cost of taxes and insurance onto your mortgage payment to determine what you can afford.

If you plan to purchase a home, you should consider how much your property taxes and homeowners insurance will cost and how both will factor into your overall homebuying budget, recommends says Britny Lawhorn, a mortgage expert and assistant publisher with Finder

Since the cost of property taxes and insurance vary from one homeowner to the next, some buyers will be impacted more than others.

“Also, consider whether you expect these costs to go up along with the costs to improve, repair and maintain your home,” she adds.

Property tax rates

Taxes on real estate can vary widely based on your state and county.

“The difference between, say, a 1 percent and 1.5 percent tax rate is huge,” says Tom Trott, branch manager for Embrace Home Loans.

“For example, if the assessed value of your home is $300,000, your property taxes would be $3,000 or $4,500, respectively, based on a 1 percent or 1.5 percent tax rate. The monthly escrow you would pay toward those taxes would range from $250 to $375.”

Trott explains, “If you earn $5,000 monthly in income, you would experience a 2.5 percent increase in your DTI ratio based on this tax rate alone.”

Two kinds of insurance

When talking about taxes and ‘insurance,’ understand there are two different kinds of insurance counted toward your DTI.

“First, there’s your homeowners insurance, which covers you in the event there is a loss to your property, such as with fire, theft, injury or other damage to your home,” says Trott.

The second type is mortgage insurance.

“Mortgage insurance covers the financial institution that owns your loan. If you went into default, the mortgage insurance pays your lender for any loss as a result of the default,” Trott says.

Mortgage insurance is typically required if you put down less than 20% on a home loan. It usually takes the form of private mortgage insurance (PMI) on a conventional loan or mortgage insurance premium (MIP) on an FHA loan.

The amount you pay will depend on your loan type, down payment, and credit score.

DTI calculation example

Let’s say your gross monthly income (the amount you make before taxes and other deductions are taken out) is $7,000.

Assume your monthly debt payments total $2,500:

  • $1,500 — Estimated monthly mortgage payments ($1,150 for loan principal and interest, plus $50 for homeowners insurance and $300 for property taxes)
  • $300 — Monthly car payments
  • $300 — Monthly student loan payment
  • $400 — Credit card minimum payments and other monthly debt obligations

Mortgage payment with principal and interest estimated using The Mortgage Reports mortgage calculator. Your own monthly payment will vary based on your interest rate, location, and more.

To get your DTI you would divide $2,500 by $7,000, which would yield a ratio of approximately 36%.

That’s well within the amount most lenders will approve; some even allow debt-to-income ratios as high as 45% or 50%.

Note that in this example, the monthly mortgage payment includes property taxes and homeowners insurance premiums. HOA dues would typically also be included if the property is part of a homeowners association.

If you make a down payment of less than 20%, you’ll likely also have to pay for private mortgage insurance (PMI) which would be included in your DTI as well.

Other monthly housing expenses, like utilities, are not included.

The higher your property taxes, homeowners insurance, and mortgage insurance premiums, the less room you’ll have left in your budget for principal and interest payments.

That means taxes and insurance can have a significant impact on the loan amount a mortgage lender will approve you for.

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Front-end vs. back-end DTI

Lenders often calculate two separate debt-to-income ratios: front-end DTI and back-end DTI.

“The front-end ratio is only comprised of your housing-related debt,” says Trott. “This includes your monthly mortgage-based payment of principal and interest, property taxes, monthly mortgage insurance if applicable, homeowners insurance, and homeowners or condominium association dues if applicable.”

Trott explains that if property taxes and homeowners insurance are totaled as a yearly amount, that sum is divided by 12 to estimate the average monthly amount that would go toward the front-end ratio.

The back-end ratio, on the other hand, includes housing expenses plus monthly payments on all other outstanding debt, according to Panza.

“These other outstanding debts can include credit cards, student loans, car loans, alimony payments, child support, and installment debts,” she says.

What DTI ratio do lenders want to see?

Lenders prefer a DTI ratio that’s within an acceptable range or below a particular threshold.

“Lenders often prefer a DTI of 43 percent or lower for conventional loans or FHA loans, and 41 percent for USDA and VA loans,” says Lawhorn.

“Some loan programs allow borrowers to exceed these limits if they meet certain qualifying criteria.”

In his experience, Trott has observed lenders being flexible with some of these limits.

“Fannie Mae and Freddie Mac back-end ratios often need to be less than 50 percent or even lower if your credit score is not as strong. FHA and VA loans can often go as high as 55 percent, depending on compensating factors such as credit, discretionary income, and liquid assets,” he says. “USDA loans usually require a 29 percent maximum on the front-end ratio and 43 percent on the back-end ratio.”

New DTI rules offer more flexibility

Note that a new qualified mortgage (QM) rule has resulted in lenders being more flexible about debt requirements.

“Previously, lenders were required to strictly stick to the 43 percent DTI limit,” says Lawhorn.

“But under the new QM rule, while lenders must still assess a borrower’s DTI they can take into consideration the types of debts the borrower has. And they can consider expected future income rather than sticking to a numerical calculation.”

How does DTI affect your mortgage?

As mentioned, your DTI ratio will impact your ability to qualify for different kinds of loans–including conventional, FHA, VA, and USDA loans.

But DTI isn’t the only criteria lenders look closely at.

“Credit scores are also important, as many programs have minimum credit score requirements. The amount you can put toward your down payment is also important,” says Trott.

To improve your odds of getting approved and being offered the best interest rates on mortgage loans, prepared to do a little homework.

“Work to boost your credit score. A score of 720 and above will get you a better rate,” Lawhorn suggests.

“Also, try to save up as much as you can so that you can afford a higher down payment. And avoid any large purchases, such as a new car, before applying for a mortgage loan.”

Taking out big debts or opening a new line of credit before you apply for a home loan can affect your credit score as well as your DTI, and might seriously reduce the amount you can borrow.

Find your home buying budget

You can estimate your home buying budget using today’s mortgage rates and a mortgage calculator.

Or, if you’re ready to start house hunting, you can get pre-approved by a mortgage lender. This will give you a verified budget and the clout you need to make a competitive offer on a home.

Ready to see how much home you can afford?

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Erik J. Martin
Authored By: Erik J. Martin
The Mortgage Reports contributor
Erik J. Martin has written on real estate, business, tech and other topics for Reader's Digest, AARP The Magazine, and The Chicago Tribune.