What is debt-to-income ratio (DTI) and how does it affect your mortgage?

Quick insights

• Debt-to-income ratio (DTI) measures the amount of debt you have against your overall income.
• It’s one of the most important factors in your mortgage applications because it gives lenders a good idea of whether you’ll be able to make your monthly payments.
• Generally, a good debt-to-income ratio is lower than 36%, but that doesn’t mean a DTI higher than that will disqualify you from a home loan.ec-fannie-mae-dti-2022

If you're a first-time homebuyer, the mortgage process may, at times, seem overwhelming. Even if you earn a steady income and pay your bills on time, other variables could affect your chances of getting a mortgage.

Debt-to-income ratio (DTI) is one metric lenders will look at to assess your financial situation. Let’s take a closer look at how to calculate debt to income ratio and what a good ratio means for mortgage loan approval.

What is debt-to-income ratio (DTI)?

Debt-to-income ratio (DTI) measures the amount of debt you have against your overall income. It’s a way for lenders to assess your financial health and creditworthiness.

If a large chunk of your income goes toward paying down debt, that means your DTI is high. In contrast, if a small percentage of your income is spent on debt, your DTI is low. Lenders typically want to see that your DTI is low, as it tells them you'll be able to manage your monthly payments with minimal issues.

Lenders also look at the history and trajectory of your debt-to-income ratio. Say, for example, you increased your income from $100,000 to $250,000 in one year. A home lender may not automatically underwrite a much larger loan—they’ll want to understand the why behind the jump. Was it a big salary increase? A one-time sale of a house or stocks? Will that $250,000 income continue?

How can I calculate my debt-to-income ratio?

The easiest way to calculate your debt-to-income (DTI) ratio is to add up all your monthly debt payments and divide that amount by your gross monthly income. Let’s walk through the steps in more detail:

1. Add up your monthly debt payments

Begin by totaling your monthly debt payments. These should include payments for:

• Rent or mortgage
• Student loans
• Credit cards
• Car loans
• Personal loans
• Lines of credit
• Child support or alimony

Generally, expenses such as taxes, gas, utilities, insurance and groceries aren’t included in debt-to-income ratio calculations, as these are considered living expenses.

2. Divide the total by your income

Divide the debt number you just calculated by your total gross monthly income (income before taxes). Include all sources of income, including your salary from full-time work, any part-time wages or freelance income, bonuses, social security benefits or child support payments received.

The formula to calculate your DTI is as follows:

DTI = (Total of your monthly debt payments / your gross monthly income) x 100

The result is expressed as a percentage.

3. Review your final number

The number you generated in the previous step is your debt-to-income ratio (DTI). The lower the DTI percentage, the less risky you tend to be to lenders.

Most lenders rely on what’s called a “back-end” ratio when calculating DTI, which refers to the portion of your income needed to cover all of your monthly debt obligations (such as credit cards and student loans) plus your housing expenses.

However, there are some that calculate based on a front-end ratio, which only shows what percentage of your monthly gross income would go toward housing expenses.

Debt-to-income ratio example

If you pay $1,500 a month for your mortgage, $200 a month for an auto loan and $300 a month for remaining debts, your monthly debt payments add up to $2,000. If your gross monthly income is $6,000, then your debt-to-income ratio is 33% ($2,000 is 33% of $6,000).

On the other hand, if your gross monthly income is $6,000, and you are paying $3,000 in monthly debt, your debt-to-income ratio is 50%.

In this case, you would be considered "house poor,” a term used to describe homeowners living beyond their means by spending most of their income on housing costs (including mortgage, taxes and insurance).

Why is debt-to-income ratio important?

In addition to your income, lenders will review related housing expenses, such as condominium dues and homeowner association (HOA) assessments, insurance premiums, mortgage insurance and other recurring obligations.

While a high credit score is considered good, a low debt-to-income ratio is a more important factor. It helps lenders see the bigger picture of your finances, providing reassurance that you’ll be able to make your monthly payments. Put simply, this information helps lenders minimize the risks associated with approving your loan.

Limitations of the debt-to-income ratio

Just because you might qualify for a $500,000 mortgage, doesn’t mean you’ll actually be able to afford that amount for the long term. So use your judgment before signing on the dotted line.

While DTI is a great tool you can use to get an idea of how much you can afford, it doesn’t take into account future variables, such as salary changes, inflation or other potential expenses. It also doesn’t distinguish between different types of debt. For example, student loans are lumped into the DTI calculation with credit cards, despite typically being lower interest.

Another misconception is that your debt-to-income ratio is the same as your credit utilization ratio. However, DTI ratio is your monthly debt payments compared to your income, while credit utilization measures your debt balances against the amount of existing credit you’ve been approved for by credit companies.

Both are helpful metrics when it comes to determining your credit health, but they are different numbers with different meanings.

What is a good debt-to-income ratio?

Generally, a good debt-to-income ratio is lower than 36%, but that doesn’t mean a DTI higher than that will disqualify you from a home loan.ec-fannie-mae-dti-2022 If you have a higher DTI, your lender might ask you to meet other eligibility requirements. For example, you may need to make a higher down payment or get a cosigner.

However, some lenders may accept higher ratios depending on what kind of loan you’re applying for. Some conventional loans backed by Fannie Mae and Freddie Mac now accept a DTI as high as 50% if it goes through manual underwriting.ec-fannie-mae-dti-2022 Talk to your lender about what ratio you should aim for.

Remember, reducing your debt is a smart move because it will boost your credit score and lower your DTI ratio over time.

What is the 28/36 rule?

The 28/36 rule is a general approach used to calculate how much debt an individual should assume.

The rule is that a household should spend no more than 28% of its gross monthly income on total housing expenses (including mortgage debt, insurance and property taxes) and no more than 36% on debt in total.

Lenders use this formula to determine how much debt a consumer can sustainably take on without overextending themselves and potentially defaulting on loans. Using this rule to figure out what percentage of your income you should spend on your mortgage is smart, since it allows borrowers to have slightly higher DTIs as long as they have better credit scores. 

How to lower your debt-to-income ratio (DTI)

If you’re concerned about your mortgage debt-to-income ratio, there are a few ways to approach the situation.

You can reduce your DTI by increasing your income or paying off loans and credit card accounts. If your lender won’t calculate earnings from side jobs as income, you can use the extra money to pay down debt. You can also allocate funds from bonus pay or a cash windfall to reduce debt.

Lenders also look at student loan debt when calculating debt-to-income ratio. Whether it will count against you depends on the type of loan and whether the payments are current or have been deferred.

Debt management to-do list

If you’ve decided that you’re going to buy a home and want to reduce your debt-to-income ratio, here’s a to-do list that might help.

• Make sure your credit is in order. Check your credit report to make sure there aren’t any discrepancies and to keep track of your credit score. Avoid opening any new credit accounts so you can get the lowest possible mortgage rate.
• Figure out your debt-to-income ratio. Determine how much more debt you can handle without drastically tipping the scales.
• Understand how much you can afford as a down payment. Are those funds ready to use, or will you get help from your family?
• Have a cash cushion. Home lenders will look at how many months of cash reserves you have. So you should have enough saved to keep making mortgage payments for a few months if your income dips unexpectedly. 
• Double-check your comfort level. Ask yourself again: Are you truly comfortable borrowing an amount into the six figures and making that monthly mortgage payment?
• Pay off debt. Do your best to reduce debt, especially high-interest debt, like credit card payments.

In summary

Your debt-to-income ratio is a metric that compares your debt payments to your income. Lenders use this ratio to determine how you’ll be able to manage debt, plus additional loan payments. 

While the ideal debt-to-income ratio is lower than 36%, you aren’t automatically disqualified from a home loan if yours is above that.ec-fannie-mae-dti-2022 Take steps to reduce your DTI and talk to your lender about your options. Keeping your DTI within a reasonable level will increase your odds of becoming a homeowner (and getting the best rate possible). In most cases, the less debt you have, the better.