What is the debt-to-income (DTI) ratio?
A debt-to-income (DTI) ratio is a comparison between your income and your monthly debt payments.
Your DTI ratio becomes a consideration if you are trying to get a mortgage to purchase a home or property or applying for a home equity line of credit (HELOC).
In these cases, lenders will ask to see proof of employment and income as well as a list of your monthly debt payments. Lenders use this information to calculate your DTI. If you are applying for the loan jointly with a spouse or another individual, the lender will calculate the DTI of both people.
A high DTI ratio indicates to lenders high risk for not being able to afford a mortgage loan. For example, you could have a high income but high debt as well, or you could have a lower income and high debt. Either way, if your DTI is more than 43%, you may not be approved for a mortgage. However, some lenders may be willing to do a mortgage with a DTI ratio up to 50%.
A low DTI ratio indicates to lenders that you are low risk and can likely afford to make monthly mortgage payments in addition to paying your current debts. An ideal DTI ratio is less than 36%, yet some lenders may approve a loan if DTI is up to 43%. Having a high credit score can help because it shows you are able to pay your debts.
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Types of DTI
Front-end DTI
This ratio takes into consideration all the expenses that are related to a house or property, including your rent or mortgage payments, property taxes, homeowners' insurance monthly payments, and homeowners associate dues (if applicable).
To calculate front-end DTI, add your housing-related debt and divide this number by your monthly income. For example, if you have monthly gross income of $6,000 and pay $2,500 in monthly housing payments, you will have a front-end DTI ratio of 41%.
Back-end DTI
This takes into consideration the amount of your income used to pay all monthly debt including your current rent or mortgage, plus credit cards, student loans, and a car loan.
For example, if you have a monthly gross income of $6,000 and $3,000 in monthly liabilities (a $2,500 monthly mortgage/insurance payment and $500 in credit card payments), you will have a back-end DTI ratio of 50%. In this case you would not likely qualify for a mortgage loan.
Lenders will consider both your front-end and back-end DTI ratios to decide your risk as a borrower. Different lenders have unique lending criteria, and each type of mortgage loan program has unique requirements as well. Working with an experienced mortgage loan officer can help you get the mortgage that works best for your financial position.
If you are now able to get approved for a mortgage or HELOC, you may need to save more money for a home or build your credit score.
How to calculate your DTI ratio
- Add up your monthly payments (including loans, credit cards, and child support, excluding utility, phone, and food expenses).
- Divide monthly payments by gross monthly income (the amount of money you have earned before your taxes and other deductions are taken out).
- Convert to percentage.
Example debt to income ratio calculation:
If you pay $1,800 a month for your mortgage and pay $350 a month for an auto loan, then $1,800 + $350 = $2,150 monthly debt.
If your gross monthly income is $6,000, then your debt-to-income ratio is 35%
($2,150 ÷ $6,000 = .35).
Why is debt-to-income ratio important?
The DTI ratio provides mortgage lenders with a general idea regarding a borrower's level of risk for defaulting on a mortgage loan. While there are exceptions to every rule, the DTI formula has been a reliable predictor of consumer risk, which all mortgage lenders follow during the loan approval process.
What is a good debt-to-income ratio?
Less than 36%. This is the ideal debt to income ratio that lenders are looking for. A DTI ratio below 36% means you can likely take on new debt.
36% to 42%. This range may still be acceptable for getting a mortgage loan; however, you may want to
pay off credit card debt to lower and improve your DTI ratio.
43% to 50%. Some mortgage lenders may not approve a loan for people with a DTI ratio in this range, as it indicates that the individual may not be able to handle additional monthly debt payments.
Over 50%. If you have a DTI ratio over 50 and you want to get a mortgage you will need to try increasing your income and reducing your debt. It may take some time but with effort it is possible.
DTI requirements for home loans
Here are general requirements for several of the most popular mortgage loan categories:
FHA loans. An
FHA loan is a type of government-insured mortgage loan that has more relaxed qualifying requirements than conventional mortgage loans provided by private lenders. A DTI of 43% is generally required, although some lenders may allow a higher DTI.
USDA loans. The ideal debt to income ratio is up to 41% for a USDA loan, which is a type of government-insured
non-conforming mortgage loan.
VA loans.
VA mortgage loans are insured by the U.S. Department of Veterans Affairs, VA loans are available to qualifying U.S. Armed Forces veterans, active duty service members, certain reservists and National Guard members, as well as certain surviving spouses of deceased veterans. The DTI ratio requirement is 41%.
Conventional loans.
Conventional mortgage loans are the most common type of mortgage. The DTI ratio for conventional loans may be up to 50%; however, most lenders prefer a DTI ratio of no more than 43%.
How to lower your debt-to-income ratio
Pay off small debts. By paying off outstanding credit card balances and other small loan balances could be enough to decrease your DTI ratio.
Increase income. If you can't quickly pay off your debts, you may consider taking a second job or seeking a higher paying job. Increased income and reduced debt can lower your DTI ratio.
Add a co-signer. Adding a co-signer to a mortgage loan can help you get approved. Lenders will look at your combined income and debts and combined DTI.
Don't open new credit or loans. To help keep your DTI ratio low, do not open new credit card accounts or apply for a new loan several months before applying for a mortgage.
New credit is one of the factors that affects credit scores.
FAQs
Debt-to-income ratio vs. debt-to-limit ratio: what's the difference?
The debt-to-income (DTI) ratio is a comparison between an individual's income and their monthly debt responsibility. The debt-to-limit ratio is a comparison of the amount of credit an individual is using to their total available credit.
Does DTI affect your credit score?
No, DTI does not directly affect your credit score. However, if you have made late payments on your outstanding debts or have high debt, this may be indicated by a low credit score. Mortgage lenders will look at your credit score as part of the loan approval process, so it is important to
improve your credit score.
How quickly can I improve my DTI ratio?
This depends on how much debt you have or how quickly you can get a higher paying job. If you can do both within a matter of a few months, then you should be able to lower your DTI ratio.
Can I apply for a home loan with a high DTI ratio?
Yes, anyone can apply for a home loan. However, if you know you have a high DTI ratio you may want to wait until you've paid off your debt, such as credit cards, before applying. Even if you can qualify for a mortgage, it's smart to make sure you're in a good financial position so you'll be able to make on-time monthly loan payments.
Is rent included in DTI?
Yes, your current monthly rent or mortgage payment is included in the DTI ratio calculation.
Why savvy consumers choose CU SoCal
For over 60 years CU SoCal has been providing financial services, including mortgages, Home Equity Loans, HELOCs, car loans, personal loans, credit cards, and other banking products, to those who live, work, worship, or attend school in Orange County, Los Angeles County, Riverside County, and San Bernardino County.
Please give us a call today at 866.287.6225 today to schedule a no-obligation loan consultation with a CU SoCal Member Services specialist.
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