Debt-to-Income : How to Calculate Your for Mortgages

Your Debt-To-Income (DTI) ratio is one of the most critical numbers lenders review when you apply for a mortgage, auto loan, credit card, or other credit. This comprehensive guide will explain what debt-to-income ratio means, walk through how to calculate yours, and provide tips for improving your DTI to boost approval odds.

How to Calculate Your DTI Ratio for Mortgages and Loans

Key Takeaways – Debt-To-Income

  • The debt-to-income (DTI) ratio compares total monthly debt payments to gross monthly income. Below 36% is generally preferred.
  • Mortgage lenders DTI focused on housing costs. Other lenders use back-end DTI to cover total debts.
  • Each loan type – mortgages, auto, credit cards – has different ideal DTI ranges for approval.
  • A high DTI ratio makes qualifying for affordable credit more challenging.
  • Reducing DTI requires focused debt repayment, limiting new creditors, and leveraging refinancing/consolidation options.

Introduction to Debt-to-Income (DTI) Ratio

Your DTI ratio compares the amount you owe each month to the amount you earn. It shows what percentage of your gross monthly income is consumed by debt payments.

The Debt-To-Income formula

Monthly Debt Payments / Monthly Gross Income x 100 = DTI Ratio %

For example, if you have $2,500 in total monthly debt payments and $7,000 in gross monthly income: 

$2,500 / $7,000 x 100 = 35.7% DTI

DTI ratio is important because lenders use it to assess your risk of missing payments or defaulting on debts. Lower DTI percentages indicate more disposable income left after paying debts, while higher percentages mean your income is strained by debt burdens.

How to Calculate Your Debt-to-Income Ratio

Calculating your DTI ratio involves 3 key steps:

Tally Your Monthly Debt Payments

Add up the total minimum monthly payments due on all your debts. Common debts included are:

  • Mortgage or rent
  • Auto, student, and personal loans
  • Credit card minimum payments
  • Child support and alimony
For example, if you pay

$1,500 mortgage
$700 total loan payments
$300 credit card minimum payments
$100 alimony

Your total monthly debt payments = $1,500 + $700 + $300 + $100 = $2,600

Determine Your Gross Monthly Income

Add up income from all sources before deductions like taxes. Include:

  • Salary/wages from full-time and side jobs
  • Self-employment or freelance income
  • Investment returns
  • Government benefits
  • Pensions
For example, if you earn:

$5,000 per month salary after taxes
$1,500 average monthly freelancing income
$500 monthly rental property profit

our gross monthly income = $5,000 / (1 - .30) + $1,500 + $500 = $7,500

(Note: To get a gross salary, divide the post-tax amount by 0.7 based on ~30% tax rate)

Plug Amounts into DTI Formula

Monthly Debt Payments / Monthly Gross Income x 100 = DTI Ratio %

Using our example figures:

$2,600 monthly debt payments / $7,500 gross monthly income x 100 = 34.7% DTI

So this fictional borrower has a 34.7% DTI ratio.

Types of Debt-to-Income Ratios

There are two primary types of DTI ratios – front-end and back-end:

Front-End Debt-to-Income (DTI)

Front-end DTI only includes housing costs (mortgage/rent, insurance, property taxes, HOA fees) divided by income. It’s primarily used for mortgage lending.

Front-End DTI Formula:
Monthly Housing Costs / Monthly Gross Income x 100

Back-End Debt-to-Income (DTI)

Back-end DTI incorporates all monthly debt payments including housing divided by income. It’s used for non-mortgage lending like auto, personal, student loans, and credit cards.

Back-End DTI Formula:

Total Monthly Debt Payments / Monthly Gross Income x 100

Back-end DTI provides a fuller financial picture, so carries more weight in non-mortgage credit decisions.

Ideal DTI Ratios by Loan Type

Preferred DTI ratios vary somewhat depending on the loan product based on underwriting guidelines:

Mortgage Loans

  • Front-end DTI – Below 28% is preferred, up to 31% allowed for FHA mortgages
  • Back-end DTI – Below 36% is good. Up to 45% may be allowed with compensating credit factors.
For example, a borrower with a front-end DTI of 25% and a back-end of 40% could potentially qualify for a mortgage since the back-end ratio is within tolerance levels.

Auto Loans

  • Back-end DTI – 15-35% considered prime. Up to 50% may be approved with additional stipulations.
A borrower with a 28% back-end DTI would be in the prime range for best auto loan rates.

Personal Loans

  • Back-end DTI – Below 35% preferred. Up to 40-45% may be tolerated with good credit.
For example, a back-end DTI of 38% could still potentially qualify for a personal loan, but may have higher rates.

Credit Cards

  • Back-end DTI – No fixed requirements, but lower percentages improve approval odds. Above 50% often leads to denials.
A borrower with a back-end DTI in the 30-35% range is likely to get approved for a higher credit limit versus someone with a 50% ratio.

How to Improve Your Debt-to-Income Ratio

If your DTI ratio is too high, take these actions to reduce it and improve your chances of loan approval:

  • Pay down balances – Accelerate repayment, especially on high-interest credit cards and loans. Pay more than the minimum each month.
  • Limit new credit – Avoid applying for additional loans or credit cards until your debt-to-income DTI ratio lowers. New inquiries also temporarily ding credit scores.
  • Increase income – Take on a side job or freelance work. Ask your current employer for a raise. Have a non-working spouse or partner seek employment.
  • Refinance/consolidate – Consolidate debts through balance transfer cards, personal loans, or refinancing to get lower interest rates and monthly payments.
  • Credit counseling – Non-profit credit counseling services can provide personalized guidance on debt reduction.
For example, consolidating $15,000 in credit card balances to a personal loan at 10% interest instead of 20% interest could reduce monthly required payments and thus lower your DTI ratio.

Consequences of a High Debt-to-Income Ratio

Falling outside lender debt-to-income DTI tolerance levels negatively impacts finances:

  • Higher loan rates – A high Debt-To-Income (DTI) ratio leads to higher interest rates and fees on approved loans and credit cards.
  • Credit denials – Debt-to-income DTI ratios above 50% often result in denials for new credit applications.
  • Lower borrowing capacity – High Debt-To-Income (DTI) reduces approval chances and lowers the maximum loan amounts you can qualify for.
  • Financial stress – A strained budget increases stress and the risk of missing payments or default.
  • Delayed goals – Difficulty getting approved credit delays financial goals like homeownership or owning a reliable vehicle.
  • Credit score impact – Over time, high Debt-To-Income (DTI) drags down your credit score by driving increased utilization.

That’s why it’s important to maintain a Debt-To-Income (DTI) ratio in lender-recommended ranges.

Frequently Asked Questions

How often should I Recalculate my DTI ratio?

Re-evaluate your DTI at least every 6 months and whenever you apply for new credit. Changes in income, debts, or expenses can alter the ratio.

What debts are Excluded from DTI ratio Calculations?

Excluded debts are non-debt expenses like utilities, groceries, insurance premiums (except mortgage insurance), transportation costs, and income taxes.

Can I get a mortgage with a 50% Debt-To-Income (DTI) ratio?

It is unlikely unless you have very strong compensating factors like excellent credit scores, substantial assets, and a sizable down payment. Most lenders avoid back-end DTI above 45% for mortgages.

What’s the Minimum Credit Score Needed for a good Debt-To-Income (DTI) ratio?

While credit score alone doesn’t determine approval, scores below 620 make it very difficult to qualify for affordable loan terms even with a lower DTI ratio. Prime DTI ratios have the most impact on borrowers with scores above 660.

How long does it take to improve my DTI Ratio if I pay off debts?

Paying down credit cards and loans produces an immediate improvement in DTI calculations. However, lenders like to see 6-12 months of reduced obligations before extending major new credit.

Should I PAY OFF Student Loans or Auto Loans First?

Generally, pay off whichever has the higher interest rate first, as that saves more on interest expenses long-term. Paying off smaller balances can also provide a motivational boost.

What’s the Maximum Mortgage Debt-To-Income (DTI) ratio for VA loans?

VA does not publish fixed limits, but carefully scrutinizes DTI above 41%. They also consider residual income left after debts. Approval of up to 50% DTI is possible with very strong compensating factors.

Is Joint Spousal Income Counted Toward DTI for credit cards?

For personal credit cards, lenders generally only count the income of the primary applicant. But for jointly held credit cards, combined spousal income may be used to calculate Debt-To-Income (DTI).

This comprehensive guide covers key aspects of debt-to-income ratio calculations, evaluation, and improvement strategies. Please drop your comments below this post to let my team know if you need any clarification or have additional questions!

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