Your debt-to-income ratio (DTI) is one of the most important figures that will determine how much home you can afford. It measures the amount of your monthly debt payments against your monthly income. In other words, lenders look at your DTI to determine if you can afford the loan payments.
Lenders often look at your total monthly payments in calculating your DTI, otherwise known as a backend or total debt ratio (another less common DTI ratio is called frontend DTI ratio, which only considers housing-related expenses in relation to your income).
From a lender’s perspective, the lower your DTI, the greater ability you have as a borrower to make your monthly payments. Common types of home loans that consider your DTI include a rate and term refinance, cash-out refinance, home equity loan, and home equity line of credit (HELOC).
The 2 types of DTI
As mentioned, there are two types of DTI calculations that you should know about — “frontend” and “backend” debt-to-income (DTI) ratios, often referred to as “housing expense ratio” and “total debt ratio,” respectively. The most commonly used figure is the backend DTI.
- Frontend DTI or Housing Ratio: This ratio specifically considers the borrower’s housing-related expenses, such as mortgage payments, property taxes, and homeowner’s insurance, as a percentage of their gross monthly income.
- Backend DTI or Total Debt Ratio: This ratio takes into account all of the borrower’s monthly debt obligations, including housing expenses, credit card payments, car loans, student loans, and other recurring debts, as a percentage of their gross monthly income.
The maximum allowable frontend and backend ratios will vary depending on the lender and type of loan you’re applying for. For example, conventional loans rarely look at the frontend ratio, and can allow up to a 50% backend DTI in some cases. Federal Housing Administration (FHA) loans, on the other hand, typically allow a maximum frontend ratio of 31% and 43% for the backend ratio.
How to calculate your debt-to-income ratio
While calculating the DTI may seem straightforward, there are lesser-known exceptions and circumstances that can benefit you as a borrower. To calculate your DTI, you can use the formula below:
- Frontend DTI = Sum of all housing-related payments / Gross monthly income
- Backend DTI = Sum of monthly debt payments / Gross monthly income
For example, someone who has to make $4,000 in monthly housing payments, $1,000 in other debts, and earns $10,000 in gross monthly income would have a frontend ratio of 40% and a backend DTI of 50%.
There are some nuances, however, with what is included with the monthly debt payments. The same is true for how gross monthly income is determined.
What is included with monthly debt payments?
Monthly payments that are considered in the debt-to-income (DTI) calculation include the following four main categories:
- Monthly housing payments on all properties you own, which typically consists of the principal, interest, taxes, and insurance (PITI) of your mortgage payment. This should also include any second mortgage loan payments, mortgage insurance, flood insurance, and homeowner’s association dues if applicable);
- Monthly loan payments appearing on your credit report, such as credit card payments, federal loans, debt consolidation loan and auto loan payments;
- Federal or state-mandated payments or wage garnishments, such as installment payments to the IRS, child support, or alimony;
- Other personal/private loan payments, such as promissory notes you have with a family member or other individual;
What is not included with total monthly debt payments for purposes of DTI?
Not all of the bills you pay are included in the calculation of the DTI. If you have an expense that does not fall into one of the categories mentioned above, chances are it will not be counted against you when a lender calculates your DTI.
Here are some examples of common monthly payments that lenders do not add to your DTI:
- Utility payments (such as gas, electric, trash, and water bills);
- Childcare expenses;
- Phone and internet bills;
- Subscriptions to digital streaming services;
- Home security monthly monitoring fees;
How is monthly gross income determined?
For purposes of calculating your debt-to-income ratio, a lender’s determination of your monthly income will depend on whether you run your own business, or are employed by another company.
As a W2 salaried or hourly employee, your income will be based on your pre-tax earnings. Deductions from your paycheck such as payroll taxes, state and federal taxes, and retirement allocations have no impact on your DTI.
As self-employed borrowers, lenders rarely disclose the exact methodology used in determining your income. However, most will follow similar calculations to this Fannie Mae income worksheet. Lenders will consider you self-employed if you have 25% or more ownership interest in a business, are a sole proprietor, or are someone who receives tax form 1099 instead of a W2 from clients.
How to increase the income portion of DTI
If you receive bonuses, tips, commissions, or overtime pay, make sure your lender is aware of this as it you’ll be able to make a stronger case that you can afford a larger loan amount. Most lenders will look for a two-year history of receipt of the income to evaluate your average monthly earnings and whether it is trending up or down.
If you are self-employed, you should know that writing off expenses — while it can help reduce your taxable income — can also negatively impact the income a lender considers for the purposes of calculating your DTI.
How to decrease your liabilities for DTI purposes
It’s possible that some of your loan payments can be excluded. This depends on the guidelines for the type of loan you’re applying for. It can also vary from lender to lender.
If you’re having trouble getting approved for a loan because your debt-to-income ratio is too high, here are some common examples of debts that you can ask your lender to consider excluding. Lenders should catch these items before you notice, but oversights can commonly occur:
Debts paid by others
If you are legally obligated to pay a debt but another individual has been making the payments, it’s possible to omit this debt from your DTI calculation. In most cases, you’ll need to provide proof that the other individual has made timely payments for at least the past 12 consecutive months.
Debts paid by your business
If you have business debts that appear on your personal credit report, you may want to provide proof that they were deducted from the income on your business tax returns.
Housing expenses for co-owned properties
If you own other properties but are not responsible for the housing payments, property taxes, or homeowner’s insurance, you may be able to have that debt omitted if you can provide proof of someone else making the most recent 12 consecutive payments in a timely manner.
Installment loans with fewer than 10 payments remaining
Installment loans with fewer than 10 payments remaining are considered short-term debt, and could be excluded from your DTI calculation. Some examples of installment debt can include auto loans, mortgages, personal loans, and student loans.
Recently paid off debt
Credit reports do not always have the most recent information. If you have recently paid off or paid down the balance on a loan, you may want to provide the lender with a loan statement so that it considers the most accurate information.
Frequently Asked Questions (FAQs)
How do lenders get my monthly debt payment information?
Lenders get most of the information about your debt obligations by pulling your credit report. Other sources of information, such as public records, can provide information on things like property taxes. In some cases, a lender may be able to view the presence of a debt but may require you to provide additional details. This can sometimes occur with things like child support or alimony, where payment details may not be easily accessible.
Can I see what my lender gets when they pull my credit report?
You can pull your own credit reports to know what information a lender will see. You’ll want to view the three major credit bureaus: Experian, Transunion, and Equifax. You can utilize AnnualCreditReport.com to obtain one free copy of your credit report each year. Doing this does not hurt your credit score. You may also view additional information on this from the Federal Trade Commission website.
It’s important to note that the information on your credit report can change daily, including credit scores and credit card balances. It depends on when creditors provide updated information to the credit bureaus. As a result, the information your lender sees may vary slightly from the credit report copies you pull, so the calculations for debt-to-income ratios may vary slightly.
Why does my credit report show the wrong balances or payment info?
Many creditors report the balance once per month. As a result, it’s possible that the balance you see on the credit report does not match your current balance if you’ve recently made a payment.
Additionally, creditors will report the minimum monthly payments required, even if you pay off the balance in full. This monthly payment figure is typically minimal, but if your DTI is borderline, then it could mean the difference between a loan approval or denial.
How to lower debt-to-income ratio figures for a loan
If you’re looking to get any type of mortgage, including refinances or home equity loans, you can use the tips we’ve mentioned above to calculate your DTI. It will give you an idea of what figure your lender will come up with, and allow you to double-check the lender’s evaluation of your DTI. Another added benefit is that if you notice any discrepancies or you are denied for too high of a figure, you’ll be able to more knowledgeable question how the lender came to that conclusion.