Mortgage debt-to-income ratio defined

What is a debt to income ratio?

Mortgage lenders use the debt-to-income ratio, or DTI, to compare your monthly debt payments to your gross monthly income.

Your DTI ratio tells lenders whether you could afford to make the payments on a new mortgage loan. In other words, the DTI measures the financial burden that a mortgage would place on your household.

Here's what you should know about DTI and how it affects your mortgage eligibility.

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Simple definition: debt-to-income ratio (DTI)

The debt-to-income ratio (DTI) shows a person's monthly debt obligations as a percentage of their gross monthly income.

For example, if your monthly pre-tax income is $5,000 and you have $2,000 in monthly debt payments, your DTI is 40 percent. Debt that counts toward your DTI includes things like minimum credit card payments, car loans, student loans, and your mortgage.

Mortgage lenders charge DTI for all purchase mortgages and for most refinancing transactions.

Your DTI ratio can help answer the question, "How much house can I afford?"

DTI does not indicate your willingness to make your monthly mortgage payment. It only measures the economic burden that the mortgage would place on your household. Most mortgage regulations impose a maximum DTI limit.

Maximum DTI by type of loan

Your lender's maximum DTI limit depends in part on the type of loan you choose:

Conventional Loan: Up to 43% typically acceptable (36% is ideal)FHA loan: 43% normally allowed (50% possible)USDA loan: 41% is typical for most lendersVA loan: 41% is typical for most lenders

These rules do not always apply equally to all borrowers.

For example, even if your DTI meets the requirements of your loan, you are not guaranteed approval. Your credit rating, deposit amount, or income could still affect your eligibility.

And it works the other way around, too: some borrowers whose DTI ratios are a bit high may still qualify if they have excellent credit or can make a larger down payment than required.

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Calculate your debt to income ratio

DTI measures your debt as a percentage of your income. Here is the formula:

Monthly Debt Obligations (divided by) Monthly income (just) 100 (same) DTI

For someone who owes $2,000 each month and earns $5,000 in wages, the equation would look like this:

$2,000 ÷ $5,000 x 100 = 40% DTI

To calculate your own DTI, you need to know the following:

What Debts Need to Be Include in Your Monthly Debt Commitments? How much of your income should be taken into account?

It's not always a simple equation for mortgage borrowers.

Calculating income for a mortgage approval

Mortgage lenders calculate income a little differently than expected. For example, there's more to consider than just the take-home reward.

Lenders also do special calculations for bonus earnings; grant credit for certain individual tax deductions; and apply specific guidelines for part-time work.

The simplest income calculations are for W-2 employees who do not receive a bonus and do not make itemized deductions.

For W-2 employees, the lender typically reviews your payslips and uses the annual average to determine your gross income and monthly household income.

Complex income scenarios

When you receive bonus income, your lender looks for a two-year history and calculates your annual bonus as a monthly number that you can add to your mortgage application.

For self-employed borrowers and applicants who own more than 25% of a business, calculating income is a bit more complicated.

To calculate a self-employed borrower's income, mortgage lenders typically add up adjusted gross income as reported on tax returns for the most recent two years, and then add certain claimed write-offs to that final result. Next, the total is divided by 24 months to find your monthly household income.

Income that is not reported on tax returns or not yet claimed cannot be used for mortgage qualifying purposes.

In addition, all mortgage applicants are eligible to use regular ongoing payments to top up their mortgage income. Annuity payments and annuities can be claimed as long as they continue for at least another 36 months, as can Social Security and disability payments from the federal government.

Non-taxable income may be used at 125% of its monthly value.

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Calculating Debt for a Mortgage Approval

For most mortgage applicants, calculating debt is more complex than calculating income. Not all debt on a credit report should be included on your DTI, and some debt not listed on a credit report should be used.

Lenders divide debt into two categories: front-end and back-end.

front end Ratio: Includes debts related to housing expenses: for example, your mortgage payment, property taxes, and homeowner's insurance premiums backend Ratio: Includes minimum payments to your credit card companies, car and student loan payments, and your total monthly housing payment

Find your front-end DTI

Your front-end DTI shows the cost of your new home as a percentage of your monthly income.

To calculate your front-end debt, add your mortgage balance and interest payment to your other monthly housing expenses.

These additional housing costs can be your:

Annual property tax bill (divided by 12 to show monthly payments) Annual homeowner insurance premiums (divided by 12 to show monthly obligations) Monthly fees paid to a homeowners association (HOA) Any private mortgage insurance premium (or FHA mortgage insurance premium). added to your monthly mortgage payment

Find your backend DTI

To calculate your backend DTI like a lender, add the following numbers together, if applicable:

Your total monthly home payment (calculated above) Monthly minimum credit card payments Monthly car loan payments Monthly personal loan payments Monthly student loan payments Monthly child support and/or child support payments Any other monthly payments not listed on your credit report

Note that several exceptions to this list apply. For example, if you have a car loan or other payment with 10 or fewer outstanding payments, the debt does not need to be included in your DTI calculation.

Student loans whose payments are deferred at least 12 months in the future can also be omitted. However, you need documentation for this.

Dividing the total of this debt by your gross monthly income and then multiplying the result by 100 gives your back-end DTI.

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Some common DTI examples

Now that you know how to calculate DTI, you can find ways to get a lower DTI before applying for a loan.

Reducing your debt or increasing your income will lower your DTI, which could help you qualify for a better mortgage loan.

Here are some examples of DTI in action:

Calculating a DTI of 25%

Monthly Social Security Income (assumed 125%): $6,000 Monthly Recurring Debt: $500 Monthly Housing Payment: $1,000

Calculating a DTI of 40%

Monthly W-2 income (before taxes): $10,000 Monthly recurring debt: $1,500 Monthly housing payment: $2,500

Calculating a DTI of 45%

Monthly self-employment income: $10,000 Monthly recurring debt: $2,000 Monthly housing payment: $2,500

What is a good debt to income ratio?

Traditional lending often requires homebuyer DTIs of 43% or less.

In some cases, loan approvals are possible with DTIs as high as 45% or even higher – particularly for FHA loans. But mortgage applicants with high DTI ratios need to show strength in another aspect of their application.

This "other aspect" may include a large down payment, an exceptionally good credit rating, or large reserves in the bank or as an investment.

Also note that lenders stop tracking debt-to-income ratios once a loan has been approved and funded. It is a metric used for credit approval purposes only.

After you qualify for the loan, it's up to you to make sure you can afford the payment by keeping your credit card debt and other obligations at bay.

What DTI should I aim for?

As a rule of thumb, your DTI should be between 36% and 43% when applying for a mortgage.

However, a lower debt-to-income ratio is always better. The lower the debt-to-income ratio, the better the mortgage rate you get.

DTI is an important factor in home affordability for many borrowers: if a low DTI helps you avoid high-yield mortgage loans, you can afford a more expensive home.

Check Your Mortgage Eligibility (January 14, 2022)

Loans not using DTI for approval

Mortgage lenders use DTI to see if houses are "affordable" for a US home buyer. They check income and debt.

However, there are several high-quality mortgage programs that are more flexible in how the DTI is calculated. These include loan options from the FHA, the VA, and Fannie Mae and Freddie Mac.

The FHA Streamline Refinance

The FHA offers a refinance program called FHA Streamline Refinance that specifically ignores DTI, even if it is a high DTI that would not qualify for an FHA purchase loan.

The official FHA mortgage guidelines also waive the income test and credit check as part of the streamlined refi process. Instead, the FHA is trying to see that the homeowner made the home's existing mortgage payments on time and without problems.

If the homeowner has a perfect payment history going back three months, the FHA considers the homeowner to be earning enough to "pay the bills."

The VA Interest Reduction Refinancing Loan (IRRRL)

The VA Interest Rate Reduction Refinance Loan (IRRRL) is another refinance program that eschews traditional DTI rules.

Similar to the FHA Streamline Refinance, the IRRRL guidelines require lenders to verify a strong mortgage payment history rather than collecting W-2s and payslips.

VA Streamline Refinance is only available to military borrowers who already have a VA loan. Homeowners must also demonstrate that there is a benefit in refinancing their existing home loan – either in the form of a lower monthly payment; or a switch from an ARM to a fixed rate loan.

RefiNow and Refi possible

Fannie Mae and Freddie Mac recently launched new refinance programs to help low-income homebuyers.

Fannie Mae's RefiNow program and Freddie Mac's Refi Possible program are both extremely flexible in terms of qualifying borrowers with a high DTI. With RefiNow, borrowers can even qualify with a debt-to-income ratio of up to 65%.

If you are currently on an unaffordable mortgage but are unsure if you would qualify for refinance due to a high DTI, ask your lender about these two programs.

Get today's mortgage rates

Today's average mortgage rates remain near all-time lows.

A lower DTI can help you secure those historically low rates, meaning you could save on housing costs for decades to come.

To see where you stand, get a free price quote today.

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