How to Calculate Debt-To-Income Ratio

Figure Out Your Debt-to-Income Ratio

Commonly referenced simply as DTI, it takes into consideration how much you spend each month compared to your gross income. The debts considered in this calculation are your recurring debt payments such as car, credit card, student loan, alimony/child support, and other payments.  The cost of owning your home is also included in this debt calculation, mortgage payments, real estate taxes, and homeowners’ insurance is examples.

Your debt commitment does not include monthly expenses such as groceries, utilities, telephone, and auto insurance.

Example: Determine your debt-to-income ratio (percentage)

Let’s say Nancy wants to buy a house where the proposed mortgage payment with real estate taxes and insurance (known as PITI) is $2,200. Nancy also has monthly student loan payments of $100, a car loan payment of $250, and credit card payments of $100 a month. Nancy makes $90,000 per year which is $7,500 gross income per month.

What does my DTI need to be?

DTI requirements vary by programs and can also vary by lenders for the same mortgage. Typically, a DTI of 43% or less will get you qualified for most programs but in some cases higher than 50% is acceptable for certain government loans.

Keep in mind that certain debts can be excluded from your DTI to help if your DTI is high. For example, if you have less than 10 payments left on a car payment, that payment might not have to be added into the calculation.  Speak to your Loan Officer to get guidance on this.

What Do Debt-To-Income Ratios Mean When Getting a Mortgage Loan?

It depends on the loan program and the lender, but the national DTI average is 36%.  If you have what’s considered to be a high DTI for a certain program, a thing called compensating factors such as reserves (money in the bank) can help with getting your loan approved.

DTI Ratios According to the Type of Loan

Conforming/Conventional Loans

These are loans that conform to Fannie Mae and Freddie Mac guidelines. Fannie and Freddie are government-backed entities that create a stable mortgage marketplace.  These entities don’t originate (write) loans but buy them from other mortgage companies.  These companies underwrite loans per the guidelines that Fannie and Freddie put out for all to see.  Fannie and Freddie typically want to see a DTI of 43% or lower but in some cases, lenders will go above that depending on the borrower’s credit score, the loan to value, and the borrower’s reserve levels.

Non-Conforming JUMBO Loans

Fannie Mae and Freddie Mac allow certain loan amounts known as the conforming loan limit, which is based on the average home price in different counties throughout the country.  Jumbo loans are loans that are above this loan limit and are held by institutions as part of their loan portfolio.  Because the loans are typically larger, the lenders are more conservative with DTI and usually never go over 43%.

FHA and VA Loans

These types of loan programs are originated by private mortgage companies but carry a form of mortgage insurance that is run by the U.S. government.  The insurance protects the lender against certain losses in case of default.

These types of loans usually allow for a higher DTI compared to other mortgage programs.  There are instances that your DTI can exceed 50% depending on your credit score, your reserves, and the loan to value of your mortgage.  Each situation can be unique, and the lender will ultimately make their decision based on your overall loan package and risk.

How Can You Improve Your DTI?

If you find that your debt-to-income ratio is higher than allowed by mortgage lenders, there is a lot you can do to improve it. The idea is to either increase your income or decrease your debt. Here are some ideas to help you:

• Pay more towards debt: Pay more than your minimum on credit cards to pay off the principal balance quicker. For example, if you owe $1,000 on your credit card with a 20% annual interest rate and make a minimum payment of $20, it’ll take more than eight years to pay off your debt! Lowering your monthly debts is one of the best ways to improve your DTI and also your credit score.
• Increase your income: Obviously easier said than done but if possible, ask for a raise. Lenders will look at your current income if based on hourly or salary, so getting a raise can give you an immediate lift. One of the other ways you can increase your income is to change employers if the right opportunity becomes available.  Be careful here; you need to make sure it’s in the same line of work.  Going from being an Accountant to a computer technician could put you at risk of not qualifying.  Most lenders look for a two-year history in the same line of work to consider your income stable.
• Use a balance transfer offer to consolidate debt for a lower payment: There are much low-interest credit card offers out there that will allow you to transfer your other high-interest credit card balances to the new card.  This will create a lower monthly payment which will help lower your DTI.
• Buying a lower-priced home: In some cases, if your DTI is too high, adjusting your sites on which house you might buy could help.  Shop around, and you may find a home that you love that’s 20% less than you originally thought about that could make the difference.

By now, you should see that your debt commitments and income are critical when it comes to getting approved for a mortgage.

Your debt-to-income ratio can make or break your application for a loan. Plus, it’s closely connected to your credit utilization, which makes up 30% of your FICO credit score.  A high DTI also is burdensome from month to month, because it means a large percentage of your income is going towards loan payments.

By paying attention to your monthly debt load and working towards reducing your DTI, you will begin saving money and having an easier time qualifying for the home you want.

Photo credit: Photo by Karolina Grabowska