What Is Debt-To-Income Ratio And Why Does It Matter?

Making the decision to buy a home is a huge step, but the process involves more than just touring properties and finding the home of your dreams. Unless you’re paying cash for the home, you’ll need to finance the purchase with a mortgage.

Mortgage lenders want to make sure you’re in good financial shape before they’ll approve your loan application – and one of the metrics they use to determine your financial strength is your debt-to-income ratio (DTI).

With this in mind, let’s take a close look at what debt-to-income ratio is and how it impacts a mortgage loan application.

What Is Debt-To-Income Ratio?

Your debt-to-income ratio compares your total monthly debt to your gross monthly income – the total amount you earn prior to tax and any insurance/401(k) withholdings. The lower your ratio, the less debt you have relative to your monthly income. The higher your ratio, the more debt you have to repay each month.

Lenders may look at two categories of DTI when reviewing your mortgage application: the front-end ratio and the back-end ratio.

The Front-End Ratio

The front-end DTI ratio looks at your future monthly housing expenses and compares them to your gross monthly income. This ratio considers factors like:

• Monthly mortgage payments
• Homeowners insurance costs
• Property taxes
• Homeowners association (HOA) fees

Front-end ratio doesn’t take into consideration any other debts or monthly expenses you may have. The purpose of this ratio is to give you insight, prior to applying for a mortgage, into your total housing costs if approved for a home loan. While lenders may not rely heavily on this ratio, they’ll still look at it to gain a better understanding of your financial situation.

The Back-End Ratio

The back-end DTI ratio is what most people think of when considering DTI. It looks at your total debt and compares it to your total monthly income. This ratio factors in your minimum monthly payments on credit card debt, mortgage loans, personal loans and other recurring debt.

Back-end DTI provides lenders a quick overview of your debt situation and whether you would be able to afford a new monthly mortgage payment. If you have too much debt relative to your monthly income, lenders may not feel comfortable giving you the home loan you’re seeking.

How To Calculate Your Debt-To-Income Ratio

You don’t have to wait until you fill out a mortgage application to find out what your DTI is. You can calculate it yourself before you start searching for a lender. Here’s how.

Total Up Your Minimum Monthly Debt Payments

You’ll want to start by compiling a list of your regular monthly debt payments. This list should include:

• Mortgage payments
• Credit card payments
• Personal loan payments
• Auto loan payments
• Student loan payments
• Child support payments

Be as detailed as you can when totaling your debts. The more information you can include in your DTI calculation, the more accurate your ratio will be.

Add Up Your Total Monthly Income

Once you have a firm list of expenses, you’ll want to total your monthly income. The income you add can come from anywhere, including your regular salary or pay, investment earnings, side hustles, tips and commissions.

If you’re a salaried worker and don’t have additional income, all you’ll have to do is look at your regular monthly wage. Since it doesn’t change, your salary will be predictable and calculating your DTI will be slightly easier. However, if you’re an hourly worker or have a variable income, you’ll want to take the average of your monthly earnings for the last 6 months to 1 year. You may also want to tread cautiously and go with a lower estimate for how much you earn each month. This will provide a better idea of what your debt-to-income ratio is in your worst months for earnings.

Divide Your Debt By Your Income

Now that you know roughly how much you’re putting toward your recurring expenses and how much you’re earning each month, you’re ready to find your ratio. To do this, you’ll need to divide your total monthly debt by your total gross monthly income.

Multiply The Result By 100

DTI is usually expressed as a percentage, and since the result you get by dividing your total monthly debt payments by your income is expressed as a decimal number, you’ll need to convert it. Simply multiply the decimal by 100. This final number is your debt-to-income percentage.

For example, let’s say that your total monthly debt is $1,800 and your monthly income is $5,000. To get your DTI, divide $1,800 by $5,000, which gives you 0.36. Then, multiply that number by 100 to get the percentage, which is 36%. You have a DTI of 36%.

How Your DTI Impacts Your Mortgage Application

You can expect almost all lenders to look at your DTI when reviewing your mortgage application. And typically, those lenders want your debt-to-income ratio to be as low as possible. The lower your ratio, the easier it will be for you to handle a new loan payment each month.

Though the requirements will vary from lender to lender, most lenders expect applicants to have a DTI of 43% or less. However, you may still be able to gain mortgage approval with a higher DTI. It’s wise to speak with a home loan expert and let them help you find the best type of mortgage for your goals and financial situation.

Ways To Lower Your DTI

Lenders want to see a low DTI and most prefer that borrowers have a debt-to-income ratio of no higher than 43%. If your DTI exceeds this or is higher than you’d like, there are ways to lower it before you submit your mortgage application.

Pay Down Your Existing Debt

The best way to begin reducing your debt-to-income ratio is to pay off your current debt. Start by making more than the minimum monthly payment on as much of your debt as you can afford. This will help decrease your total debt, thereby lowering your DTI.

Don’t Take On More Debt

The more debt you have, the higher your debt-to-income ratio will be. So, if you’re trying to lower your DTI, you’ll want to avoid taking on new debt. Avoid opening new lines of credit or taking out new loans until you apply for and are approved for your mortgage. Once you close on your mortgage loan, you can start taking out new loans or opening new credit cards as needed without having to worry about your DTI.

Find Ways To Increase Your Income

Increasing your income is another effective way to lower your debt-to-income ratio. Start thinking about how you can bring extra money home each month. This might mean negotiating a higher wage with your employer or starting a side hustle to give you a little extra income. If you have a hobby you’re passionate about, you may even be able to turn it into a money-earning activity.

FAQs About Debt-To-Income Ratio

Here are a few frequently asked questions about debt-to-income ratio so you can better prepare for starting the mortgage process.

Why is my DTI ratio so important when applying for a mortgage?

Your debt-to-income ratio tells lenders the amount of monthly debt you owe compared to your monthly income. When it’s high, it suggests that you may struggle to pay your mortgage. When it’s low, it shows lenders that you’ll likely be able to afford your mortgage payments without running into issues.

What is a good debt-to-income ratio for a mortgage?

Every lender has its own DTI ratio requirement. The best way to determine if you have a qualifying DTI is to speak with your lender and gain a clear understanding of their requirements. Keep in mind that most lenders prefer that borrowers have a DTI of no more than 43%. If your DTI is 43% or less, you’ll likely be able to qualify for a mortgage.

What can I do if my DTI ratio is higher than it should be?

It’s possible to lower your DTI ratio. Pay down your existing debts as much as is feasible, don’t take on new debt and find ways to increase your monthly income. Taking these steps will help lower your DTI and make you a more attractive borrower to a potential lender.

Will a high DTI ratio keep me from being able to buy a house?

A high DTI may not prevent you from buying a house, but it can make qualifying for a mortgage more difficult. That’s why it’s always a good idea to get your DTI as low as possible before applying for a mortgage.

Does a high DTI ratio mean I have a bad credit score?

Not necessarily. Though many people with a high DTI ratio have a lower credit score because they carry more debt each month, a high DTI doesn’t guarantee your score will be low. You can check your credit score by signing up for a Rocket Homes℠ account. 

The Bottom Line

Your debt-to-income ratio is an important tool that lenders use to determine whether you’re a trustworthy borrower. By keeping your DTI low, you’ll make it easier to qualify for a mortgage and get the loan you need to buy your dream home.

As long as you do what you can to pay off any outstanding debt and avoid taking on new debt before buying a home, you’ll set yourself up for success when applying for a mortgage.

Ready to start the home-buying process? Apply online with Rocket Mortgage^®.