That beautiful, brand-new penthouse or condominium with extra square footage may tempt you into taking out a bigger mortgage — especially when the monthly payment looks affordable. But if you’re not careful, owning your dream home can easily turn into a financial nightmare. You could end up spending so much on homeownership that you don’t have enough money left over for other daily expenses, aka being “house poor.”
Figuring out your debt-to-income ratio, or DTI, will help you better understand your ability to borrow money and repay it. Knowing this information from the get-go can help you make better-informed decisions when you’re applying for a mortgage and shopping for a home.
We’ll break down exactly what your DTI means, how to calculate it, and the recommended DTI to buy a house:
- What Is a Debt-to-Income Ratio?
- How To Calculate Your Debt-to-Income Ratio
- The Maximum Debt-to-Income Ratio for a Mortgage
- The Bottom Line
What Is a Debt-to-Income Ratio?
Your DTI is an important percentage that’s calculated by adding up your monthly debt payments and dividing the total by your gross monthly income. It projects how easily you’ll be able to make your mortgage payments, which helps lenders determine if they should grant you a loan.
There are two types of DTIs:
- Front-end DTI: Rather than examining all of your monthly debts, this figure focuses on how much of your income is allocated toward housing costs — typically your mortgage payment, plus property taxes and homeowners insurance.
- Back-end DTI: This figure looks at all monthly debt payments and financial obligations, which include housing costs plus auto loans, credit cards, student loans, personal loans, alimony, and child support.
A low DTI means you make significantly more money than what you owe each month, so you’re more likely to comfortably cover your mortgage payments. A high DTI means you have a lot of debt compared to how much you earn, so you might run into trouble with repayment.
Certain home loans don’t have a maximum front-end DTI requirement. Your back-end DTI captures your monthly cash flow more clearly than your front-end DTI, which only considers how much you spend on rent or your mortgage relative to debt. However, lenders will still look at both types of DTIs when they’re assessing your risk as a borrower.
How To Calculate Your Debt-to-Income Ratio
To arrive at your DTI, you’ll first need to figure out your total monthly debt payments and gross monthly income. This process can be confusing, so consider these tips as you complete the calculations:
- When determining your back-end DTI, be sure to account for the minimum monthly payments on all of your recurring debts and financial obligations.
- Your gross monthly income isn’t your take-home pay — it’s your earnings before taxes and other deductions, like your health insurance premium or 401(k) contribution, are taken out.
Once you have both figures, divide your debt payments by your gross income to get your DTI.
It’s easier to understand this calculation with an example. Susie, a first-time homebuyer, is looking to apply for a mortgage and wants to figure out her DTI. Here’s a list of Susie’s monthly bills and her income:
- Rent: $800
- Car loan: $400
- Credit card payment: $300
- Student loans: $200
- Income before taxes and other deductions: $4,000
Susie’s total monthly debt payment is $1,700:
$800 + $400 + $300 + $200 = $1,700
And her gross income is $4,000, so her back-end DTI is approximately 43%:
( $1,700 / $4,000 ) x 100 = 42.5%
Let’s add Mary, Susie’s wife, to our example. If you’re purchasing a home with another person, lenders will use both of your debts and incomes to calculate your DTI. Mary lives with Susie and pays for half of their $1,600 rent. Here’s a list of Mary’s monthly bills and her income information:
- Rent: $800
- Child support: $400
- Credit card payment: $100
- Income before taxes and other deductions: $5,000
Mary’s total monthly debt payment is $1,300:
$800 + $400 + $100 = $1,300
Her gross income is $5,000, so her back-end DTI is 26%:
( $1,300 / $5,000 ) x 100 = 26%
Now, to calculate Susie and Mary’s household DTI, we’ll add up their total monthly debt payments and divide by their combined gross monthly income.
Susie and Mary’s total monthly debt payments amount to $3,000:
$1,700 + $1,300 = $3,000
Their combined gross income is $9,000:
$4,000 + $5,000 = $9,000
So, Susie and Mary’s household DTI comes out to approximately 33%:
( $3,000 / $9,000 ) x 100 = 33.33%
Because Mary has less debt and a higher income than Susie, she lowered their household DTI, which may help the couple better qualify for a mortgage.
The Maximum Debt-to-Income Ratio for a Mortgage
The recommended DTI for home loans varies depending on the type of mortgage you’re applying for. We’ve compiled the front-end and back-end DTI limits for conventional mortgages and government-backed loans below.
|Mortgage Type||Front-End DTI Limit||Back-End DTI Limit|
|Conventional loan||N/A||36% for manually underwritten;
50% for loans underwritten through DU
Read More: The Credit Score You Need To Buy a House
Front-end DTI limit: N/A
Back-end DTI limit:
- 36% for manually underwritten loans; 45% if you meet specific credit score and cash reserve requirements
- 50% for loans underwritten through Desktop Underwriter, an automated system
Federal Housing Administration (FHA) loan
Front-end DTI limit: 31%
Back-end DTI limit: 43%
The maximum qualifying ratios may be raised to 40% and 50%, respectively, for an FHA loan if your credit score is at least 580 and you meet certain conditions — including having stronger cash reserves or no discretionary debt.
U.S. Department of Agriculture (USDA) loan
Front-end DTI limit: 29%
Back-end DTI limit: 41%
If your credit score is at least 680 and you meet certain conditions, such as having sufficient cash reserves, the maximum front-end DTI for a USDA loan increases to 32% and the maximum back-end DTI moves up to 44%.
U.S. Department of Veterans Affairs (VA) loan
Front-end DTI limit: N/A
Back-end DTI limit: 41%
Even if your DTI is higher than 41%, it doesn’t mean your loan application will be automatically rejected. Other financial factors and conditions may justify the approval of your mortgage.
The Bottom Line
Your DTI is an important number that will influence whether a lender approves or rejects your mortgage application. However, having a high DTI doesn’t automatically mean you need to give up on homeownership. If you have a partner, adding them to the loan may help lower your DTI, or you can try paying off your debts and increasing your income over time.