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How to Calculate Your Debt-to-Income Ratio

[Updated: May 04, 2020] Oct 08, 2019 by Matt Frankel, CFP
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If you're planning to buy a home, your lender will probably use your debt-to-income ratio as part of the qualification process. In simple terms, this tells the lender how "affordable" the home is, given your current income and other debts.

Here's a rundown of what you need to know about the debt-to-income ratio, how to calculate yours, and how you can use your debt-to-income ratio to determine how much house you can afford.

What is your debt-to-income ratio and why does it matter?

Your debt-to-income ratio, or DTI ratio (you’ll see both here), is an important part of the mortgage approval process.

Lenders look at a few things when deciding whether to approve your mortgage application. They’ll generally check your credit score, your assets, and your employment history. They’ll also look at your income and how affordable a particular home would be for you. This is where the debt-to-income ratio comes in.

There are two types of debt-to-income ratios your lender might use:

  • Front-end DTI: This is the percentage of your income that will be used to cover your new mortgage payment. For example, if you hear your lender say that your new housing payment can’t be more than one-third of your income, that’s a form of a front-end DTI ratio.
  • Back-end DTI: This is the percentage of your income that you’ll need to pay all of your debts, including your new mortgage payment. The back-end DTI is more important and lenders often simply referred to as your debt-to-income ratio. It’s not surprising -- it’s your overall debt picture that determines whether you can comfortably afford a certain home, not just your new mortgage payment.

Here’s a rundown of how you can calculate and interpret your own DTI ratios.

Calculating your front-end DTI ratio

Front-end debt-to-income ratio is the less important of the two in practice. However, many lenders still calculate it, so it's worth mentioning here. In short, while your overall debt picture is the better determining factor when it comes to affordability, lenders also want to make sure you won’t get in over your head with your housing payment alone.

The front-end DTI is the easier ratio to calculate. Simply take your expected mortgage payment, including principal, interest, taxes, insurance, and any HOA dues, and divide it by your monthly pre-tax income.

Say your monthly loan payment on a particular home will be $1,000 per month and your monthly income before taxes is $5,000. Dividing the two gives you a front-end DTI ratio of 20%.

Calculating your back-end DTI ratio

The back-end DTI ratio includes your new mortgage payment as well as all of your other monthly debt obligations. To calculate it, add up all of your monthly obligations and divide by your pre-tax income.

However, it’s not quite as simple as this makes it sound. Here are a few guidelines to keep in mind:

  • Only certain debts are considered for DTI purposes. This includes auto loans, student loans, credit cards, and other loan payments. It does not include things like your utility bills, auto insurance, monthly memberships and subscriptions, or similar expenses. A good rule of thumb is that if something isn’t regularly reported to the major credit bureaus, it isn’t considered in the DTI calculation.
  • For credit card debts, only consider the minimum payment you’re required to make, not the amount of the debt or how much you actually plan to pay.
  • Lenders can consider student loans differently. If your loans are in deferment or you’re on an income-driven repayment plan, some lenders will use your required payment. Others consider the amount you'd pay under a standard 10-year repayment plan. Check with your lender for their specific policy or err on the side of caution and use the full payment amount.
  • If you have an existing mortgage and you’re planning to sell your home to buy a new one, you can typically exclude your current mortgage payment from the calculation if your new home purchase is contingent on selling your current one.

Here’s an example of how this might work. Continuing the example from the previous section, we’ll say that your new monthly housing payment will be $1,000 per month and that your pre-tax income is $5,000 per month.

We’ll say you have a $400 monthly car payment, $300 student loan payment, and that the minimum payments on your credit cards add up to $100 per month. Adding the $1,000 mortgage payment gives you a total of $1,800 of monthly debt obligations. Dividing this by your income gives a back-end DTI ratio of 36%.

What DTI ratio do you need to buy a home?

There’s no easy answer to this question. Debt-to-income ratio requirements vary significantly among lenders.

The traditional guidelines are that a front-end DTI ratio should be 28% or less and a back-end DTI ratio should be 36% or less. However, many lenders originate mortgages with a back-end DTI of 45% or more in some cases, depending on the borrower’s credit, the geographic location of the home, and other factors.

In short, if you have strong credit, I’d suggest using a 45% DTI when establishing the top end of your home-buying budget. As I mentioned, while some lenders will calculate both your front- and back-end DTI, your overall debt-to-income (back-end DTI) tends to be far more important in practice.

Using DTI to determine your budget

If you’re trying to figure out how much house you can afford, you can use these calculation methods to work backwards and determine your maximum mortgage payment.

For example, let’s say your lender will approve loans with a maximum DTI ratio of 45%. You earn $5,000 per month, so multiplying $5,000 by 45% shows that your overall debt burden cannot be more than $2,250 per month.

If your other debts (car, student loans, credit cards) add up to $800 per month, subtracting this from $2,250 reveals that you could potentially get approved for a monthly housing payment of $1,450.

The exact dollar amount of the home you can afford cannot be determined with your maximum housing payment. Different homes can have significantly different property taxes and insurance costs, even in the same market. And some homes might have HOA dues while others don’t. Furthermore, this doesn’t include any information about your down payment.

But, by knowing the maximum housing payment you can afford, you can use a mortgage calculator to determine if a certain house will fit into your budget.

The bottom line on DTI ratios

Your debt-to-income ratio is an important part of the mortgage qualification process. If your debts are too high to justify the loan, you could be disqualified even if you have stellar credit and a steady paycheck. DTI ratio requirements vary from lender to lender, but it’s rare to find a lender who will accept a back-end DTI ratio above 45%.

By knowing how to calculate your debt-to-income ratio, you’ll have a good idea of whether you’re in good financial shape to get a loan for the house you want before you walk into a lender’s office.

Keep in mind that just because a DTI ratio calculation says you can afford a certain home price doesn’t mean that you need to spend that much. Many people aren’t comfortable spending 45% of their income on debt payments -- when you add in things like taxes, groceries, and other things that aren't considered in the DTI calculation, such a high debt load could be overwhelming. So, in addition to determining if a home meets your lender’s DTI standards, it’s still important to make sure your new housing payment will fit your budget.

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