Did you know that most lenders use a 43% debt-to-income ratio (DTI) as the upper limit for approving mortgages? This number is a key factor in determining whether you’ll qualify for major loans like a mortgage or personal loan. Your DTI ratio gives lenders insight into your financial health and ability to handle new debt.
Knowing your DTI can help you plan for loan applications and understand how much debt you can reasonably take on. With a clear calculation, you can assess your current financial situation and make adjustments as needed to improve your chances of loan approval.
What is debt-to-income ratio?
Your debt-to-income ratio (DTI) is a measure which compares your monthly debt payments to your gross monthly income to determine if you could afford more loan payments.
It’s a way for lenders to evaluate your level of risk as a borrower before approving your loan application. From their perspective, if you already have a lot of debt compared to the amount of money you bring in, it may be harder for you to repay another loan. That means the risk of loan default is higher the more debt you have.
On the other hand, if your debt-to-income ratio is low, it indicates that you’re more likely to have available income to put towards another loan. So, the better your DTI ratio, the better chance you have of getting your loan application approved.
How to Calculate Your Debt-To-Income Ratio
How to Calculate Your Debt-to-Income Ratio
Calculating your debt-to-income ratio (DTI) is simple. Use this formula:
DTI = (Total Monthly Debt Payments ÷ Gross Monthly Income) × 100
Example 1: Adding a Car Loan
Let’s say your monthly debt includes:
- A mortgage payment: $1,200
- A credit card minimum payment: $100
- A student loan payment: $200
Your total monthly debt payments add up to $1,500. If your gross monthly income is $5,000, your DTI is:
$1,500 ÷ $5,000 = 0.30, or 30%
Now, imagine you add a $400 car loan payment. Your new monthly debt total is $1,900, increasing your DTI to:
$1,900 ÷ $5,000 = 0.38, or 38%
This change might still keep you eligible for many loans but pushes you closer to the threshold for mortgage approvals.
Example 2: Paying Off Credit Card Debt
Let’s take the same scenario, but instead of adding a car loan, you pay off the $100 credit card balance entirely. Your new debt total is $1,400, lowering your DTI to:
$1,400 ÷ $5,000 = 0.28, or 28%
This lower DTI makes you a more attractive borrower, potentially qualifying you for better loan terms.
Expenses That Factor Into Your Debt-to-Income Ratio
When calculating your debt-to-income ratio (DTI), certain monthly payments are included, while others are not. Here’s how it breaks down:
Included in DTI:
- Rent or mortgage payments
- Minimum credit card payments
- Auto loans
- Student loans
- Child support or alimony
- Personal loans or other recurring debt payments
Excluded from DTI:
- Utilities (e.g., electricity, water, internet)
- Groceries and dining expenses
- Health, auto, or home insurance premiums
- Savings contributions
Why This Matters for Borrowers
Lenders use your DTI to evaluate your ability to manage additional debt. They may pull your credit report to confirm balances on loans and credit cards. However, credit reports don’t always reflect recent payments, which could make your DTI appear higher than it actually is.
If you’ve made large payments recently, ask about a rapid rescore. This process updates your credit report in just a few business days, ensuring lenders see the most accurate information. It’s a helpful option if you’re on the edge of qualifying for a loan.
By knowing what’s included and taking steps like reducing debts or requesting a rapid rescore, you can improve your DTI and strengthen your loan application.
How DTI and Credit Scores Are Connected
While your debt-to-income ratio (DTI) doesn’t directly impact your credit score, the two are closely linked through your overall financial health. Here’s how they relate:
Indirect Effects on Your Credit Score
High balances on credit accounts can increase your credit utilization rate, which is a significant factor in calculating your credit score. For example:
- If you have a $10,000 credit limit and a $7,000 balance, your utilization rate is 70%, which could lower your score.
- Reducing that balance to $3,000 drops your utilization to 30%, a level more favorable to creditors.
Even though DTI isn’t part of your credit report, lenders often look at both metrics to assess your financial habits.
Paying Down Debt Improves Both
Lowering your debt can positively affect both your DTI and your credit score:
- For DTI: Reducing monthly payments—like paying off a credit card—lowers your total debt obligations, improving your ratio.
- For Credit Scores: Lower balances reduce your credit utilization rate, which contributes to 30% of your score.
By addressing your debts strategically, you’re not only improving your chances of loan approval but also strengthening your credit profile.
Ideal Debt-to-Income Ratios for Loan Approval
A lower debt-to-income ratio (DTI) is generally better for loan approvals, but different lenders have specific thresholds depending on the type of loan.
Standard DTI Preferences
Many conventional mortgage lenders prefer DTIs below 43%, as this is often the maximum allowable ratio for a qualified mortgage. If your DTI exceeds this limit, it can be harder to get approved without significant compensating factors, such as excellent credit or a large amount of cash reserves.
To calculate the 43% cutoff, multiply your gross monthly income by 0.43. For example, if your pre-tax income is $4,000 per month, 43% of that is $1,720. This means your total monthly debt obligations—including your mortgage—should not exceed $1,720.
For borrowers who want to be more conservative, many experts recommend staying closer to 36%. Using the same $4,000 monthly income, this would limit your total monthly debt payments to $1,440.
Government-Backed Loan Exceptions
Government-backed loans, like those offered through the FHA, VA, or USDA programs, often allow for higher DTIs:
- FHA loans may approve borrowers with DTIs up to 55%, particularly if they have stable income or additional financial strengths.
- VA loans for veterans and USDA loans for rural properties also allow flexibility, with limits often depending on the lender and borrower’s overall profile.
Knowing where your DTI stands and understanding these thresholds can help you determine the type of loan and lender best suited to your financial situation.
Steps to Lower Your Debt-to-Income Ratio
Reducing your debt-to-income ratio (DTI) can improve your chances of loan approval and strengthen your overall financial health. Here are practical strategies to help you lower your DTI:
Avoid Accumulating More Debt
Taking on new debt without increasing your income can raise your DTI, making it harder to qualify for loans. To avoid this:
- Delay large purchases that require financing until after you’ve improved your DTI.
- Use credit cards sparingly and pay off balances in full each month to prevent additional monthly obligations.
Pay Down Existing Debt
Paying down your debt can have the most immediate impact on your DTI. Focus on:
- Paying off high-interest debts first, such as credit cards, to free up monthly cash flow.
- Making extra payments on smaller debts to eliminate them faster.
For example, if you owe $2,000 on a credit card with a $100 monthly minimum payment, eliminating this debt reduces your DTI by that $100.
Refinance Loans
Refinancing can lower your monthly payments by securing a lower interest rate or extending the loan term. Consider:
- Refinancing student loans to consolidate them into a single, lower-interest payment.
- Exploring mortgage or auto loan refinancing options to reduce monthly costs.
For instance, refinancing a $300 monthly car loan to $250 could immediately lower your DTI.
Increase Your Income
Boosting your income is another effective way to improve your DTI. Ideas include:
- Side gigs: Consider freelancing, online tutoring, rideshare driving, or selling products online.
- Negotiating a raise: Demonstrate your value to your employer and request higher pay.
If your monthly income increases from $4,000 to $4,500 while maintaining the same debt payments, your DTI automatically improves.
Summary of Strategies and Their Impact
| Strategy | Expected Impact |
|---|---|
| Avoid Accumulating More Debt | Prevents DTI from rising further |
| Pay Down Existing Debt | Frees up monthly cash flow |
| Refinance Loans | Lowers monthly payments |
| Increase Income | Improves DTI by increasing gross income |
Bottom Line
Your debt-to-income ratio is more than just a number—it’s a tool to help you achieve financial goals. Start today by calculating your DTI, identifying areas to improve, and taking actionable steps to lower it.
Whether it’s paying down debt, increasing your income, or exploring refinancing options, small changes can make a big difference. By managing your DTI effectively, you’ll be in a stronger position to qualify for better loan opportunities and build long-term financial stability.
Frequently Asked Questions
How does debt-to-income ratio affect mortgage interest rates?
While your DTI doesn’t directly set your mortgage interest rate, it’s a factor lenders use to determine how risky you are as a borrower. A lower DTI ratio may help you qualify for more competitive interest rates, while a higher DTI might lead to higher rates or additional conditions for approval.
Is there a difference between front-end and back-end DTI ratios?
Yes, lenders often look at two types of DTI ratios:
- Front-end DTI: Focuses on housing costs, such as mortgage payments, property taxes, and insurance, compared to your income.
- Back-end DTI: Includes all monthly debt obligations, like credit cards, auto loans, and housing costs.
Both are important, but back-end DTI is typically used more often for loan decisions.
Can I qualify for a loan with a high DTI ratio?
It’s possible to qualify for a loan with a high DTI ratio, but it often depends on the type of loan, lender flexibility, and your overall financial profile. For instance:
- Government-backed loans, like FHA or VA loans, may allow higher DTIs.
- Lenders may approve high DTI applicants if they have strong credit scores or significant cash reserves.
Should I calculate my DTI using net income instead of gross income?
While calculating DTI with net income can give you a more realistic picture of your finances, lenders typically use your gross income to determine loan eligibility. It’s a good idea to be aware of both for personal financial planning.
How often should I check my debt-to-income ratio?
It’s helpful to check your DTI ratio regularly, especially if you’re planning to apply for a loan, make a major purchase, or adjust your budget. Monitoring your DTI can also help you track progress as you work to pay down debt or increase income.
Can I lower my DTI ratio quickly before applying for a loan?
Yes, there are some short-term strategies to lower your DTI quickly:
- Pay off smaller debts entirely.
- Refinance high-payment loans to reduce monthly obligations.
- Avoid taking on new debt until after your loan application is approved.
What happens if my DTI changes after preapproval?
If your DTI increases after preapproval, it could impact your final loan approval. Lenders often recheck your financial situation before closing, so avoid taking on new debt or making large purchases until your loan is finalized.
Can I exclude certain debts from my DTI calculation?
Some debts, like loans that will be paid off within six months or debts covered by another person, may not be included in your DTI calculation. Check with your lender for specific exclusions.
How does having a co-borrower affect my DTI ratio?
When applying with a co-borrower, lenders consider the combined income and debt of both parties. This can lower the DTI ratio if the co-borrower has little debt or significant income, improving your chances of approval.
