How to Calculate a DTI for a Mortgage?
Debt-to-Income (DTI) ratio is one critical metric that could stand between you and your dream home. So, it’s important to understand and manage your DTI ratio so that you can secure a mortgage with favorable terms.
Stay with us as we teach you what a DTI ratio is, how to calculate DTI, and how to improve it.
For more personalized guidance, get in touch with our mortgage specialists today!
What is a Debt-to-Income Ratio?
The debt-to-income (DTI) ratio is a key financial metric that measures the percentage of your monthly gross income allocated to debt payments.
Lenders typically examine two types of DTI ratios:
Front-End DTI
Front-end DTI, also known as the housing ratio, that focuses solely on housing-related expenses.
This includes:
- Your monthly mortgage or rent payment
- Property taxes
- Homeowners insurance
- Any homeowners association fees
Although lenders may not always emphasize this number, it offers insight into how much of your income is dedicated to housing costs.
Back-End DTI
Back-end DTI includes all your monthly debt obligations in addition to housing expenses, such as:
- Credit card payments
- Student loans
- Auto loans
- Personal loans
This ratio is more comprehensive and is the primary focus for lenders when evaluating mortgage applications. It provides a fuller picture of your monthly spending and financial commitments.
How to Calculate My Debt to Income Ratio?
Here’s a step-by-step guide for how to calculate debt to income ratio:
Step 1: List Your Monthly Debt Payments
Start by listing all your regular, required, and recurring monthly debt payments. Only include the minimum payment amounts for each debt, not the account balance or the amount you typically pay.
Step 2: Calculate Your Gross Monthly Income
Your gross monthly income is the total income you earn each month before taxes and other deductions. Make sure to include all sources of income, such as:
- Salary from full-time work
- Part-time wages
- Freelance income
- Bonuses
- Child support or alimony received
- Social security benefits
- Rental property income
Step 3: Divide Your Monthly Debt Payments by Your Gross Monthly Income
Divide your total monthly debt payments by your gross monthly income to get a decimal number.
Example:
$1,800 (total monthly debt payments) ÷ $6,000 (gross monthly income) = 0.30
Step 4: Convert the Decimal to a Percentage
Multiply the decimal result from Step 3 by 100 to convert it to a percentage. This percentage is your DTI ratio.
Example:
0.30 × 100 = 30%
So, in this example, the DTI ratio is 30%.
How Does a DTI Ratio Impact My Mortgage?
Lenders use DTI for mortgage approval to gauge your financial health and ability to manage monthly payments.
A high DTI ratio suggests that a significant portion of your income goes toward debt payments, indicating a higher risk of default. Conversely, a low DTI ratio demonstrates a good balance between debt and income, making you a more attractive borrower.
Debt to Income Ratio for Home Loans Their Implications:
- DTI below 36%: Lenders view this range favorably as it indicates manageable debt levels. 36% is the ideal DTI for mortgage.
- DTI from 36% to 41%: This range shows that you have a manageable level of debt but are starting to push the upper limit of what lenders consider comfortable. You may still qualify for a mortgage, but lenders will scrutinize your financials more closely.
- DTI from 42% to 50%: A ratio in this range often signals that you have a lot of debt, which may hinder your ability to take on additional debt. Lenders may offer less favorable terms or deny the loan application altogether.
- DTI over 50%: This indicates a high level of debt, suggesting you might struggle to repay a mortgage. Lenders typically deny applications from borrowers with a DTI ratio over 50%.
Does an FHA Mortgage Have a Different DTI Than a Conventional Mortgage?
Yes, FHA mortgage DTI ratio requirements are different compared to conventional mortgages.
FHA loans have a higher DTI allowance which makes them ideal for borrowers with higher debt levels or those who need more flexible qualification criteria. The standard maximum DTI for an FHA loan is 57%. However, individual lenders may set their own limits, sometimes requiring a DTI closer to 40%
In contrast, conventional loans are not backed by any government agency, requiring borrowers to have a more balanced debt-to-income ratio, often resulting in more stringent lending requirements.
Generally, they require a DTI of 50% or less. However, the exact DTI requirement for a conventional loan can vary based on the borrower’s financial situation, credit history, and the specific loan type.
Borrowers with a higher DTI ratio may need to demonstrate strong financial reserves or other compensating factors to qualify.
When considering which type of mortgage to go after, it’s essential to research and speak with a lender, like Rate, to understand their specific DTI requirements and how they align with your financial situation. This approach will help you find a mortgage option that suits your needs and improves your chances of approval.
How Can I Improve My Debt-to-Income Ratio?
Here are several strategies you can use to lower your DTI ratio:
1. Increase Your Income:
- Take on a side hustle: Consider freelance work, part-time jobs, or gigs like babysitting or dog walking.
- Request overtime or a raise: If available, request additional hours at work or negotiate a higher salary.
- Monetize skills or assets: Sell items online, offer tutoring services, or rent out a spare room.
2. Reduce Your Debt:
- Pay off small debts first to quickly reduce the number of outstanding balances.
- Alternatively, you can pay down high-interest debts first, saving money on interest and reducing your DTI more effectively.
- Pay more than the minimum required amount each month can help you reduce your debt faster.
3. Refinance or Consolidate Debt:
- Refinance loans*: Obtain a lower interest rate or extend the repayment term on existing loans to reduce monthly payments.
- Consolidate debt: Combine multiple debts into a single loan with a potentially lower interest rate, making it easier to manage and possibly reducing your overall monthly payment.
4. Avoid Taking on Additional Debt:
- Pause new credit applications: Hold off on applying for new credit cards, personal loans, or other forms of credit.
- Limit credit card usage: Try to pay for expenses with cash or debit to avoid increasing your credit card balances.
5. Consider Adding Another Borrower or a Co-Signer
If your partner or spouse has a lower DTI, including their income can improve your overall DTI ratio. A co-signer with a strong financial profile can bolster your application by adding their income and creditworthiness to the mix. Just make sure they understand the responsibility involved.
6. Seek Credit Counseling
Professional advice can help you manage and reduce your debt effectively.
7. Adjust your Savings Strategy
You may try temporarily redirecting funds from savings to debt repayment to lower your DTI faster.
8. Choose a Less Expensive Home
If possible, opt for a home with a lower mortgage payment to keep your DTI within acceptable ranges.
My DTI Is Where I Want It. How Can I Apply for a Mortgage?
Now that you've know how to calculate DTI in mortgage, it's time to capitalize on this knowledge by exploring the most desirable mortgage options available to you.
At Rate, we understand that navigating the mortgage process can be daunting. That's why we've streamlined our application process to make it as simple and efficient as possible with our innovative tools including:
Check Mortgage Rates
Our rate calculator allows you to see your personalized rates for whichever loan you're interested in when you provide a few details about your financial situation.
We update our rates regularly to reflect the most current market conditions, helping you make informed decisions.
Mortgage Payment Calculator
Our Mortgage Payment Calculator allows you to visualize your future financial commitments better by providing a clear breakdown of:
- Principal
- Interest
- Property taxes
- Insurance
- HOA fees
Apply with our Digital Mortgage Application
Our digital mortgage application is designed for speed and simplicity.
In just a few minutes, you can complete the application and get pre-approved. This pre-approval not only gives you a clear picture of what you can afford but also strengthens your position as a buyer when negotiating with sellers.
Debt-to-Income Ratio FAQs
1. What is a good DTI ratio for renting versus buying a home?
While the DTI ratio is crucial for securing a mortgage, it's also important for renting. Generally, landlords prefer a DTI ratio below 30% for rent, ensuring tenants can manage rent payments alongside other debts. For buying a home, a DTI ratio below 36% is favorable, but up to 43% can be acceptable depending on other financial factors.
2. How do student loans impact my DTI ratio and mortgage eligibility?
Student loans are included in your back-end DTI calculation. Lenders consider the monthly payment amount, even if payments are deferred. If your student loan payments significantly raise your DTI ratio, it might affect your mortgage eligibility. Consider refinancing or income-driven repayment plans to lower monthly payments and improve your DTI.
3. Can I include bonuses and irregular income when calculating my DTI ratio?
Yes, bonuses and irregular income can be included in your gross monthly income, but lenders typically prefer a consistent income history. To include these, you should have documentation proving a steady receipt of such income over at least two years. This helps demonstrate reliability to lenders.
4. How do mortgage insurance and HOA fees affect my DTI ratio?
Mortgage insurance and HOA fees are included in the front-end DTI calculation, which focuses on housing-related expenses. Both can significantly impact your DTI ratio by increasing your total monthly housing costs. Ensure these expenses are factored into your calculations when determining affordability.
5. What strategies can I use if my DTI ratio is close to the maximum limit?
If your DTI ratio is near the upper limit, consider strategies such as increasing your down payment to reduce your loan amount, opting for a longer loan term to lower monthly payments, or paying off smaller debts to reduce your overall debt burden. Additionally, avoid taking on new debt and explore refinancing options for existing loans to lower monthly payments.
* By refinancing, you may pay more in costs and interest over the extended term.