If you’re buying a house and getting a mortgage, you will probably hear the words “debt-to-income ratios” or DTI. If your loan officer doesn’t mention DTI, your underwriter will. In the above form, once you enter your monthly income, recurring (monthly) debt and estimated housing expense details, the debt-to-income (DTI) ratio calculator will calculate your front-end and back-end (total) ratio to help you understand your current financial situation and accurately estimate your probability of getting approved for a mortgage.
Your loan officers and underwriters will be looking at your DTI to determine if you’re worthy of a mortgage or if you’re better off living in your parents’ basement.
What is DTI?
Debt to income ratios are just what they sound like – a ratio or comparison of your income to debt. There are two ratios – a “front” ratio which consists of your proposed housing debt (principal, interest, taxes, insurance, plus PMI or flood insurance, if applicable) divided by your income. The “back” or “total” debt to income ratio is calculated by adding your proposed housing debt to your other debt, such as payments on car loans, car leases, student loans, or credit card debt (and then divided by your income).
How Is Debt-to-Income (DTI) Ratio Calculated?
How much is your estimated housing debt / expense?
Here’s how you can calculate your “front” DTI ratio: Calculate the principal and interest payment on your mortgage. You know your loan amount; you need an interest rate and term. Once you’ve done that, you need to know (or estimate) the property taxes and insurance on the home you want to buy. If you’ve seen several homes in the same area, you probably have an idea of how much property taxes are. For homeowner’s insurance, you can estimate the monthly cost at somewhere between $40-80. Add these items together and you now have your proposed / estimated housing debt.
What is not included in housing debt?
Underwriters do not include other costs associated with owning a home, such as heat, water, electric, WiFi, or routine maintenance like lawn care or painting.
What is included in other debt?
Besides the items mentioned above, underwriters will also include any payments you have to make on a monthly basis like minimum credit card payment(s), car loan and student loan payment(s), alimony, child support, payments on an IRS tax lien, or a loan against your 401k.
|Included in D:I Calculations||Not Included in D:I Calculations|
|Automobile Loans||Utility Bills|
|Personal Loans||Cable Contracts|
|Credit Cards||Rent-to-Own Furniture|
|Store Credit Accounts||Subscriptions (any kind)|
|Loans You’ve Co-Signed||Cell Phone Contracts|
|Student Loans (Calculated)||Recurring Medical Expenses|
|Alimony & Child Support Payments||Car and Health Insurance|
What do you use for income?
Usable income depends on how you get paid and whether you are salaried or self-employed. If you have a salary of $72,000 per year, then your “usable income” for purposes of calculating DTI is $6,000 per month. DTI is always calculated on a monthly basis. Now you are ready to calculate your front ratio: divide your proposed housing debt by $6,000 and you have your front ratio.
But figuring out what income to use is a big part of calculating your DTI correctly. Here are some common questions that come up in determining usable income.
Do underwriters use your gross or net pay to calculate DTI?
It depends. If you’re salaried, as in the example above, underwriters use your gross income. But if you’re self-employed, they use your net income after expenses.
What if you get paid a base salary plus bonus or commission?
This is what most underwriters do: if you get paid a base salary plus bonus or commission, they take your current base and then they add a two year average of your bonus or commission if it’s increasing from one year to the next.
Here’s an example: let’s say you make a base salary of $60,000. Last year, you got a bonus of $15,000. The year before, your bonus was $9,000, and your salary was $55,000. How much income would an underwriter use to calculate your DTI?
They would take your current base salary of $60,000 and divide it by twelve to get $5,000 a month in base income. Then they would add in a two year average of your bonus if it’s increasing. Your bonus increased from one year to the next, so they can take a two year average. Add $9,000 and $15,000 then divide by two to get $12,000 for a two year average. On a monthly basis, this would add $1,000 a month to your usable income. Your total monthly income in this example would be $6,000.
Notice that we didn’t take an average of your base income. Once you get a raise in your salary, underwriters use the current salary – they don’t average it. The way to think about it is they average the variable component of your income. Bonus, commission, overtime. These types of income aren’t guaranteed like your salary is.
What if your bonus declined from one year to the next?
Using the example above, but let’s reverse the numbers. You still have a $60,000 base salary but last year, your bonus was $9,000; the year before, it was $15,000. Since your bonus was declining from one year to the next, underwriters would just take the most recent year or $9,000. Divided by twelve means you have $750 a month to add to your $5,000 base income.
What if you’re self-employed, not salaried? How do underwriters calculate income?
With self-employed borrowers, underwriters view their income as variable, so they adopt the same approach they use for bonus or commission income. They take a two year average if it’s increasing. Self-employment income, overtime and others, will often require at least a two-year history.
If you’re self-employed, do they use your gross or your net income?
They use your net income after expenses. There are certain items they can add back such as depreciation or one time non-recurring losses.
What if you have a salaried job but you also have a part time job?
Underwriters can typically use the income from your part time job if it’s in the same line of work and you’ve been doing it for at least a year.
What if you have a part time job but you get paid off the books?
Underwriters can’t use any income that you don’t declare on your tax returns or can’t document with a W2 and paystub.
What if you get a salary from your own business? How is that treated?
If you own 25% or more of your business, mortgage underwriters will consider you self-employed and will take a two year average of your net income if it’s increasing.
Further Reading: Standards for Determining Monthly Debt and Income (CFPB)
DTI Ratio Limits
What is an acceptable DTI?
In general, qualified mortgages limit the maximum total DTI to 43%. That means you can only have 43% of your income going to housing and other debt.
Are there any exceptions to the 43% DTI limit?
Yes. FHA loans can allow DTI as high as 56.9%. Conventional loans can go up to 50%.
When is the 43% rule more likely to apply?
Jumbo loans typically stick to 43% DTI. Loans with PMI are often restricted to a 43% total ratio.
Further Reading: Debt to Income Ratios: Total DTI and How to Reduce It
|Loan Type||Front-end Ratio||Back-end Ratio||Remarks|
|FHA Loan||31||43||31/43 is recommended. Can go higher DTI with Energy Efficient Homes (EEH) and compensating factors such as verified cash reserves, minimal increase from current monthly housing payment, no discretionary debt etc.|
|Conventional Loan||28||36||Fannie Mae and Freddie Mac conforming loans have a historic max of 28/36. Lenders typically ignore front-end ratio. Back-end ratio can be 45-50% with compensating factors such as higher credit scores, larger down payment and cash reserves.|
|Jumbo Loan||31||43||Most require a DTI no higher than 40% if you’re making a < 20% down payment.|
|VA Loan||–||41||Front-end Ratio is typically ignored. Back-end ratio can go up with higher residual income, tax-free income and compensating factors such as excellent credit history, sizable down payment etc.|
Whereas many other programs cap out at hard 50% DTI, it is not uncommon to have a 60% DTI VA loan approved when the right elements are in place. VA uses “Residual Income” as a compensating factor where no other type of loan uses this, and is what usually makes a big difference in high DTI approvals.
|USDA Loan||29||41||Can go up to 32/44 max with credit score >= 680 and other compensating factors.|
DTI Ratio Limits Reference
- Credit Underwriting (Section 9 & 10)
- Debt-To-Income Ratio: Does it Make Any Difference to VA Loans?
- Debt-to-income ratio rounded to the nearest two digits for VA loans