Debt-to-income (DTI) ratio is a financial metric used by mortgage lenders to evaluate your ability to repay your debts. It compares your monthly debt payments to your gross monthly income.
Your debt-to-income ratio is a key part of the 3 “Cs” of mortgage qualifying, which are character, capacity, and collateral. DTI is related to “capacity”, which refers to your financial ability to repay the loan.
How your debt-to-income (DTI) ratio is calculated
Your debt-to-income ratio is calculated by dividing your total monthly debt payments, property taxes, homeowner’s insurance, and HOA dues (if applicable) by your gross monthly income. For example, if your monthly income is $5,000 and your monthly debt payments, property taxes, homeowner’s insurance, and HOA dues add up to $1,000, your debt-to-income ratio is 20%.
Note that items other than just the standard loan or credit card payments can be included in your debt ratio, including child support payments, 401(k) loan payments, tax lien payments, cosigned loan payments, and “imputed” student loan payments (even if your student loans are deferred).
Your debt ratio is an important qualifying factor
Lenders use debt ratios to assess the risk of lending to you. Mortgage lenders typically require you to have a DTI ratio of 43% or lower to qualify for a mortgage. However, FHA and VA financing often allow for higher debt ratios with compensating factors, such as reserves (cash, investments, etc.) and high credit scores.
It’s important to be aware of your DTI ratio because it can impact your ability to get approved for a mortgage. A high DTI ratio indicates that you may be overextended and may struggle to make your monthly debt payments. This can result in missed payments and an increased risk of foreclosure.
On the other hand, a low DTI ratio can make you more attractive to lenders, which may result in better loan terms.
Mortgage lenders evaluate two different debt-to-income ratios: a “front-end” ratio and a “back-end” end ratio. The front-end ratio compares just the monthly mortgage payment and property taxes and homeowner’s insurance to your gross monthly income. The back-end ratio compares the monthly mortgage payment, property taxes, and homeowner’s insurance and all other applicable debt obligations to your gross monthly income. Both ratios are important for mortgage qualifying.