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Debt-to-Income Calculation


If you are considering purchasing a home soon, you need to be familiar with your debt-to-income calculation. Understanding this simple math formula could mean the difference between getting approved or getting denied for a home loan.

The discussion below will explain how to calculate this ratio and how it is used by mortgage lenders to approve people to buy a home.

The debt-to-income ratio, also called the DTI ratio by the mortgage industry, is a comparison between how much money people are making versus how much is being spent on debt.

The formula looks like this:

               Total monthly debt payments ÷ monthly income = DTI

Here is a simple example that will explain how the math works.

Shawn and Linda have been married for 3 years and have saved for a down payment on a home. Shawn is an accountant earning a $60,000 per year salary and Linda is an elementary school teacher earning a $35,000 per year salary.

They have the following monthly debt payments: one car loan of $376.25, two credit cards of $65 each, and student loan payments of $486 per month. Their total monthly debt payments are

$376.25 + $65 + $65 + $486 = $992.25

Their monthly income, before taxes are removed, is

               $60,000 + $35,000 = $95,000 yearly

               $95,000 ÷12 = $7,916.67 monthly

Their debt-to-income ratio, or DTI ratio, is

               $992.25 ÷ $7,916.67 = 13%

Very simple math, and very easy to calculate.

The only thing missing is the proposed monthly house payment for their new home. According to their lender, the proposed payment on the home that they are considering is $1,285 per month. So, the new calculation would be

               ($992.25 + $1,285) ÷ $7,916.67 = 28.77%

Now that we have explained the math, let us look at some of the details of this calculation and how lenders view the ratios.

Two Ways to View DTI

Most mortgage lenders will review the DTI in two different ways. The first way is to consider the home-only ratio. This is also called the Front Ratio.

What this means is the lender will compare the proposed home mortgage to the overall income. In our example above, the front ratio would be calculated as $1,285 ÷ $7,916.67 = 16.23%

NOTE: The home mortgage payment will need to include a proposed amount for annual property taxes and the annual homeowner's insurance policy. Your lender should provide this to you when you request a mortgage estimate.

The other way to view the DTI is the calculation we did earlier, which adds all the debt, plus the proposed mortgage payment, and divides it by the monthly income. This is known as the back ratio.

As previously shown, for the example of this article, this married couple has a DTI of 28.77%

Each type of mortgage loan will have its own rules about the 2 different ratios.

A more thorough discussion below will provide expected DTI ratios for different mortgage loans.

Things NOT Included in DTI Calculations

Now that we have examined how to calculate the DTI ratios, let us look at items that are not covered by the calculations.

The following items generally are ignored when determining a DTI ratio for a mortgage loan

  • monthly utility costs for items like electricity, water, internet, etc.
  • food costs per month, whether dining out or eating at home or some other combination
  • money spent on traveling to work such as subway fees, bus fares, or other similar charges
  • Money spent on entertainment
  • Items deducted from pay for saving or investing to a retirement account
  • Monthly insurance costs for automobiles, accident coverage, or medical coverage
  • Subscriptions to items such as internet-based entertainment (Netflix, Spotify, etc.) or gym memberships, or other similar monthly items.

These items are supposed to be covered by the amount of money remaining from the DTI calculation. That is why the ratios are set up in such a way to ensure the borrower has adequate money left over after paying the mortgage and other debt.

Overlooked Items to Include in DTI Calculations

While it is easy to understand a debt payment like a loan owed on a car or a credit card, some other items are added to the DTI calculations that you may not be considering.

If you are or will be responsible for paying any of the following types of obligations, these items need to be disclosed to your lender to make the correct DTI calculations.

  • Homeowner Association or HOA dues. These dues may be paid yearly or monthly, depending on the neighborhood.
  • Child support due to a divorce decree or other legally binding agreement
  • Alimony or similar spousal payment due to a legally binding agreement.

You may be asked by your lender to provide legal documents to verify the monthly amounts for the above items to get approved for the mortgage.

Different DTI for Different Mortgages

Each kind of mortgage will have slightly different guidelines for their qualifying DTI ratios. Here are some general rules about the major types of home loans.

Conventional mortgage from Fannie Mae or Freddie Mac – These loans will examine the

Front DTI and the Back DTI. The Front DTI should be around 28% and the back DTI should be under 43%

If the borrower has a large down payment or significant cash reserves, the back-end DTI may be slightly higher.

FHA Mortgage – For FHA, the front ratio needs to be no higher than 31% and the back ratio should not be higher than 43%

Like Fannie Mae and Freddie Mac above, it is possible to get approved with slightly higher ratios. But the borrower will need to have substantial factors on their side to get approved for the higher ratios.

VA Mortgage – For the VA loan, only one ratio, which is the back ratio, is considered. The back ratio should not be any higher than 41%.

It is worth noting that the VA mortgage guidelines are strict about their DTI ratios. However, the VA home loan also has the lowest percentage of foreclosed homes as well, so there may be a reason why they stick to these rules.

USDA mortgage – USDA will allow borrowers to have up to 29% on their front ratio and 41% on their back ratio.

One final note to keep in mind when you are talking to your lender; some mortgage companies will have their own mortgage overlooks to work with. Your lender can discuss these overlays with you, but it is important to note that each mortgage underwriter may have a handful of special rules to follow when applying for a loan.

Improving Your DTI Ratios

If you are looking over your finances and realize that you have a bit too much debt to qualify for a home, there are some things you can do to lower your debt-to-income ratios and put you in a better financial position.

The easiest solution is to pay off as much debt as you can. The tried-and-true method of starting with the smallest balance and paying it off, then moving to the next largest balance, will help you to pay down your bills and give you some satisfaction during the process.

Another option is to add to your income. This could be something drastic like looking for a better-paying position at a different company but doing the same work you are doing now. Or it could be as simple as working a few hours of overtime per week at your existing job.

You can also add to your monthly income by taking on a 2nd part-time job. Keep in mind, if you get a part-time job and wish to use that revenue in your DTI calculations, you will need to have the job for a couple of years before the lender will consider the income.

A third idea is to add another person to the loan. FHA, along with Fannie Mae and Freddie Mac, have non occupying co-borrower loan options that allow for a borrower to be on the loan if the borrower does not plan to live in the home. Your lender can provide you with the details for the various types of loans and the down payment requirements for each mortgage. 

Keep in mind that cosigner debt counts against you for the debt-to-income ratio calculation.

Summing Up Debt-to-Income Ratios

The calculations for debt-to-income ratios are rather easy to understand. The most important thing is understanding that both the proposed mortgage payment and any existing debt payments will all play a major role in getting approved for a home loan. By either keeping these ratios low now or working to lower the ratios, you will set yourself up for a better chance at getting approved to purchase a home.

Additional Real Estate Resources:
For a first-time home buyer, the above information is critical in knowing how much home you can afford but there is more to it than just the ratios.

Article from Madison Mortgage Guys -
Written by Luke Skar

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