What is Debt-to-Income (DTI) Ratio?

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Numerous factors go into determining a borrower’s eligibility for a mortgage. You may be familiar with the importance of your credit score and history or, depending on the type of loan, having enough savings for a down payment. However, if you’re reading this, you must be wondering: What is debt-to-income (DTI) ratio?  

In this article, we will explain what lenders mean when they talk about your debt-to-income ratio, how it’s calculated, and what you can do to potentially improve yours.

What is your DTI ratio?

Your DTI ratio measures your monthly pre-tax, or gross, income against your monthly debt payments. It can include things like:  

• Mortgage payments 

• Credit card minimums 

• Child support payments 

• Car loan payments 

• Student loans 

Your income, of course, is comprised of the money you make from work, as well as any other consistent streams of income, such as rental income, pension, and Social Security. Now, DTI is an umbrella term. Under that, there are two kinds of DTI ratios that lenders will look at: Front-end DTI and back-end DTI.

Front-End DTI

Front-end debt-to-income ratios show how much of your gross monthly income goes to housing-related expenses. So, this ratio would account for things like mortgage payments, homeowners’ association (HOA) payments, homeowners’ insurance, and property taxes. Lenders don’t always focus as much attention on this number as they might on your back-end DTI, but it can be worth understanding for your own personal purposes, too.  

Back-End DTI

Back-end debt-to-income ratios are more commonly used by lenders when assessing borrower qualifications. The explanation of DTI above really applies to back-end DTI. It’s a measurement of all your recurring monthly obligations against your gross monthly income, giving a more complete picture of your financial situation.

Why does your DTI ratio matter?

Lenders use your DTI ratio to help paint the full picture of your ability to afford a mortgage. If your debt-to-income ratio is too high, it could signal to a lender that you would have a hard time making regular payments on the mortgage, making you a riskier borrower by that measurement. Of course, your DTI ratio is not the only factor lenders look at to build your risk profile, but it is an important one.  

Additionally, some loan types might have different acceptable ranges for DTI ratios than others, and that can also vary to some extent from lender to lender. You may have heard of the 28/36 rule, which suggests that a good front-end DTI would be around 28 percent, and a good back-end DTI would be around 36 percent.  

Don’t think of that as an actual hard-and-fast rule. It can be a helpful guiding principle for your monthly finances, but, again, acceptable DTI ratios can vary from loan to loan and lender to lender.

How do you calculate your debt-to-income ratio?

As we’ve explained, the back-end DTI ratio calculation is fairly straightforward. First, you add up all of your monthly debt obligations. If you’re applying with someone else, add both of your debt obligations together.  

Then, divide that number by your gross monthly income (again, if applying with someone, add their income here, too). Once you have that number, multiply it by 100 to convert it to a percentage. That’s your debt-to-income ratio!  

Let’s try an example:  

1. Borrower A has a $2,300 mortgage payment, a $600 car payment, and $250 for credit cards. That’s $3,150 in monthly recurring debt. 
2. Borrower A grosses $7,500 a month from their job. Divide 3,150 by 7,000 to get 0.42. 
3. Multiply 0.42 by 100 to get a debt-to-income ratio of 42%.  

How to lower your debt-to-income ratio

If you are concerned that your debt-to-income ratio could be an issue on your mortgage application, there are some steps you could consider that might help you improve it.  

Naturally, one way to improve your DTI ratio is to reduce your debt. Before applying for a mortgage, it could help to spend some time paying down debts beyond your minimums if you can afford to do so. You may also want to look into refinancing loans if rates are lower than when you first took them out.  

At the other end of the ratio, you could look for side hustles or ask for a raise at work. It would not necessarily be advisable to look for that raise by switching jobs. Lenders typically prefer to see borrowers with stable employment, so recent job changes can sometimes impact your application.  

Now, if you are planning to buy a home, it may be unlikely that you have a lot of extra cash lying around to pay down debts. That means it may take you a little while to reduce your DTI ratio. It is ultimately up to you to decide what you’d like that final number to look like and how long you’re willing to wait for it, assuming you’ve already reached a qualifying ratio for your lender.

Final Thoughts

Debt-to-income ratio is an important factor in the mortgage application process. There are a number of ways you can positively impact yours as you prepare to apply for a loan. Taking steps to reduce that ratio can potentially be a good thing for your overall financial health, too.  

When you’re ready to start applying for a mortgage, be sure to understand what lenders are looking for in your DTI ratio and how it fits into the totality of your borrower profile.