If you’re applying for a mortgage, one of the key factors mortgage lenders will look at is your DTI—or debt-to-income ratio.
That ratio, which shows the amount of your income that will go towards debt payments, gives lenders a snapshot of your entire financial situation. That helps them understand what you can comfortably afford in terms of a mortgage payment.
What Goes Into a Debt-to-income Ratio
Debt-to-income ratios come in two forms: the front-end DTI and the back-end DTI. Lenders look at both of these when considering your loan application.
Here’s how those break down:
- Front-end DTI: Also called a PITI ratio (principal, taxes, interest, and insurance), this number reflects your total housing debt in relation to your monthly income. If you take home $6,000 per month and are trying to buy a home that would require a $1,500 monthly payment, your front-end DTI would be: [$1,500 / 6,000 = .25 or 25%]
- Back-end DTI: Your back-end DTI (or “total” DTI) encompasses all your monthly debts in relation to your income. For example, if you make $6,000 a month, have a $600 car payment, a $400 student loan payment, and an expected $1,500 mortgage payment, your back-end DTI would look like this: [$600 + $400 + $1,500 / $6,000 = .41 or 41%]
For most lenders, the back-end DTI is most important, as it more accurately reflects what you can afford each month.
Debt-to-Income Ratios for Loan Types
The debt-to-income ratio your lender wants to see partly depends on the type of mortgage loan you’re applying for.
FHA and conventional loans allow for the highest DTI ratios, while USDA loans (for use in designated rural areas) and VA loans (those for veterans and military members) have the strictest DTI requirements.
Here are debt-to-income requirements by loan type:
- FHA loans: You’ll usually need a back-end DTI ratio of 43% or less. If your home is highly energy-efficient and you have a high credit score, you may be able to have a DTI as high as 50%.
- VA loans: Loans backed by the Department of Veterans Affairs usually have a DTI maximum of 41%. They do sometimes allow DTIs beyond that, as long as your income is high enough.
- USDA loans: Loans guaranteed by the U.S. Department of Agriculture mostly require a DTI of 41% or lower. Borrowers may go up to DTIs of 44% if their front-end ratio is below 32%.
- Conventional loans: In general, you need a back-end DTI of 36% or lower. If your credit score is high enough, conventional loans may allow for DTIs up to 50%.
Though the front-end DTI isn’t as important, most lenders prefer to see it at 31% or lower (29% for USDA loans). This indicates the buyer can comfortably afford their new mortgage payment on their current salary.
Improving Your Debt-to-Income Ratio
If you realize your debt-to-income ratio doesn’t cut it for the type of loan you’re applying for, you’ll need to lower your ratio before applying for a mortgage. Try the following
- Pay down your debts. Make extra payments towards other ongoing loans, and pay down credit cards with big balances. If you receive any kind of windfalls—such as a holiday bonus or tax refund—put it toward your existing debts until your DTI falls into a healthy range.
- Boost your income. Even a few hundred dollars more a month can improve your DTI, so try to increase your income wherever possible. This might mean asking for a raise, taking on freelance projects or picking up some sort of side hustle or a second job. Every little bit helps.
- Avoid taking on more debt. The more loans you take out and the higher those credit card balances creep, the worse your DTI ratio gets. Avoid opening new lines of credit until you’ve purchased a home.
Once you’re able to reduce your debts or increase your pay, recalculate your DTI and determine the progress you’ve made. As a bonus, avoiding new debts and paying off old ones should give your credit score a boost as well. This will also help your case when applying for a mortgage loan—and may even qualify you for lower interest rates.