Debt-to-Income Ratio Information for Home Buyers

People who buy a house with financing must meet the lender’s qualifications to be approved for a mortgage. One typical lender requirement is meeting a specific debt-to-income (DTI) ratio. Knowing what DTI is helps you determine if you are financially qualified to buy a house. This DTI information for home buyers details what to know about the debt-to-income ratio for mortgages.

For informational purposes only. Always consult with a licensed mortgage or home loan professional before proceeding with any real estate transaction.

What Is DTI?

The debt-to-income ratio is the total of your monthly debt payments divided by your monthly income to produce a percentage. A high debt-to-income ratio means you use a lot of your monthly income to pay off your debts and have little money left over for normal expenses and emergencies. You may hear this called back-end DTI.

Why Does DTI Matter?

Mortgage lenders must balance risk when deciding who to lend money to. The DTI ratio is one way they assess your risk. People with a high DTI are more likely to default on their mortgage payments. Those with a low DTI are low-risk borrowers; not only are they more likely to meet the lender’s qualifications, but they often have access to the lowest available interest rates. A higher DTI doesn’t write you off from being approved, but you might be given higher interest rates.

Each loan program has a different benchmark on what is a “good,” “fair,” and “poor” DTI level, but generally, 35% or less is considered “good.” Many experts recommend aiming for 43% or less. Every type of loan has different eligibility requirements.

Those with a high DTI may not qualify for conventional loans, even if their credit score is good. You may still be eligible for a different type of loan, but the terms may not be as favorable.

Those with low DTI ratios, showing their current income is well above their debt obligations, will find they have a more favorable mortgage interest rate and loan terms.

What is Included in Debt?

Not all your debt may factor into the DTI calculation. Most sources of debt do, though. All of the following is classified as debt:

• Student loans payments
• Auto loans
• Existing mortgage monthly payments
• Credit card minimum payments
• Alimony
• Child support payments

But other housing expenses, like property taxes, utilities, and homeowners insurance are not included, even if these are monthly bills. Nor is what you spend in groceries or for child care. It’s solely about your monthly debt obligation with other creditors. Monthly rent payments do count.

What Is Included As Income?

The DTI calculation includes all income before taxes, including money from W2 employment, self-employment, or passive income from investing. It does not factor in any cash reserves you have. It’s about your monthly cash flow.

The loan application will ask you to submit all sources of income and bank statements to verify your cash flow.

How Do You Calculate DTI?

Let’s say a home buyer makes $3,000 in monthly debt payments, and their gross monthly income is $7,000. Take $4,000/$7,000=0.428. This amount multiplied by 100 equals 42.8%. The buyer’s debt-to-income ratio is 42.8%.

Fortunately, people can use many debt-to-income ratio calculators to determine their back-end ratio. These calculators help prospective home buyers determine what qualifies as monthly debt to get a fairly accurate picture of their DTI. Anyone wanting to know their DTI can also call a mortgage lender to find out what they classify as recurring debt.

DTI Too High? What You Can Do

Loan approval hinges on many factors, and the debt-to-income ratio carries some weight with mortgage approval. Knowing this figure before submitting a mortgage application is worth it.

Home buyers with high DTI and who still want to buy a house must make changes to reduce their DTI using these strategies. One option home buyers have is to increase their income. For many people, this is not easy to achieve. For households where one spouse does not work, they can quickly increase their income if that person begins working. Lenders do pay attention to employment history, so they may need to stay in their job for several months to get access to better interest rates.

Additionally, prospective borrowers can pay down their current debts to work the other end of the calculation. However, for many home buyers, this only makes buying a house more difficult. The money they would use to increase monthly payments on their debts is the same money they might use to save for a down payment or for moving costs.

Still, for some with a high DTI, the only option is to pay off debt slowly and save money over some time. A debt consolidation loan may be a way to reduce the number of bills from different creditors.

In the meantime, do what you can to avoid taking on additional debt. Keep your credit utilization ratio low, or pay off credit bills to get it lower. Continuing to make on time, regular debt payments will also help your credit history when it’s time to submit a loan application.

Contact Your Real Estate Professional

If you’re a home buyer with a high debt-to-income ratio, you may still be eligible to buy a home. It depends on the type of mortgage, your credit report, and if you have enough funds for a strong down payment that shows you can make a mortgage payment affordable. Contact several reputable lenders and shop for the best home loan deals. Set realistic expectations based on your conversations and design a budget plan to keep working on improving your DTI while looking for a home. Be a careful shopper and partner with a capable real estate professional to find the house that’s right for you.

For informational purposes only. Always consult with a licensed mortgage or home loan professional before proceeding with any real estate transaction.

Updated July 2024