When applying for a home loan, lenders take into account your debt-to-income ratio. This number represents a percentage of all monthly obligations such as minimum credit card payments, auto loans and student loans plus housing costs (rent or mortgage) and child support or alimony payments.
It’s ideal to keep your debt-to-income ratio under 43% when applying for a mortgage. However, if you’re already over this mark, there are ways to get lower and still qualify for the loan.
A low debt-to-income ratio indicates you have enough income to cover all debt obligations, making a lender more likely to approve your loan application. Conversely, a high ratio suggests there may be too much debt owed which could raise red flags with lenders and lead to future financial issues.
According to 2022 FHA guidelines, borrowers with a debt-to-income ratio of 43% or lower may qualify for federally insured loans. With higher down payments or more reliable income sources, however, higher ratios may be possible. There are other strategies you can utilize to lower your DTI such as enrolling in a debt management plan or paying off other credit cards before applying for a mortgage.
Applying for a mortgage with high debt-to-income ratios can be more difficult, but there are ways to improve your financial picture and restore your credit score. These might include cutting back on payments, saving more money towards a down payment or working with a counselor to create a budget that takes into account living expenses.
Calculating Your Debt-to-Income Ratio
The initial step in calculating your debt-to-income ratio is to have an accurate understanding of how much money you make each month. This will enable you to decide how much housing costs you can afford, as well as give you insight into your overall finances and ability to meet any debt obligations that come due.
You can also utilize the free online House Affordability Calculator to estimate how much home you can afford based on your debt-to-income ratio. This tool will also indicate if your ratio is too high for mortgage approval.
Debt-to-income ratios for conventional mortgages can reach as high as 50%, but most lenders won’t accept them due to being seen by lenders as more of a risk and potentially leading to home loss.
Lenders divide your debt-to-income ratio into two categories, front-end and back-end DTIs. The front-end DTI is calculated based on how much you owe on housing expenses such as mortgage or rental payments plus any real estate taxes, homeowner’s insurance and HOA/co-op fees that may be included in monthly housing costs.
Traditional mortgage lenders commonly use front-end debt-to-income ratios (DTI) when making their decisions, but certain government-backed loan programs such as VA and FHA also use it. These mortgages have higher front-end limits than conventional loans require.