Erik J. Martin The Mortgage Reports Contributor
Having a ‘good’ DTI isn’t too hard
Your debt-to-income ratio (DTI) is one of the most important factors in qualifying for a mortgage.
DTI determines whether you’re eligible for the type of mortgage you want. It also determines how much house you can afford. So naturally you want your DTI to look good to a lender.
Luckily, that’s not too hard. Today’s mortgage programs are flexible, and a wide range of debt-to-income ratios fall in or near the ‘good’ category. So there’s a good chance you can get approved as long as your debts are manageable.
What’s a good debt-to-income ratio?
Different mortgage programs have different DTI requirements. And lenders get to set their own maximums, too. So a ‘good’ debt-to-income ratio can vary based on your circumstances.
In general, you want to aim for a debt-to-income ratio around 36 percent or less but no higher than 43 percent. Here’s how lenders typically view DTI:
- 36% DTI or lower: Excellent
- 43% DTI: Good
- 45% DTI: Acceptable (depending on mortgage type and lender)
- 50% DTI: Absolute maximum*
Brian Martucci, a mortgage expert with Money Crashers, notes that a ratio of 36 percent is often cited as the cutoff below which your DTI is considered ‘good.’
However, you don’t need a DTI below 36% to qualify. In fact, it’s more common for lenders to allow a DTI up to 43%.
Having a ‘good’ DTI matters less than having a DTI that works with your personal finances and home buying goals
The 43% DTI rule for mortgages
The most common type of loan for home buyers is a conforming mortgage backed by Fannie Mae or Freddie Mac.
To qualify for a conforming loan, most lenders require a DTI of 43% or lower. So ideally you want to keep yours below that mark. (This is sometimes known as the ‘43% rule.’)
Jared Maxwell, vice president and direct sales division leader for Embrace Home Loans, explains: “Each homeowner’s situations, goals, and future income opportunities are different. But a ratio below 43 percent will typically help you qualify for most loan programs.”
“This means your monthly debt can only be 43 percent of your gross monthly income, before taxes,” explains Ralph DiBugnara, president of Home Qualified.
DTIs higher than 43%
It may be possible to get approved with a debt-to-income ratio above 43%.
“Historically, a DTI ratio of 45 percent was the maximum acceptable DTI for Fannie Mae loans, which meant it was very difficult to qualify for a conventional mortgage above that threshold,” says Martucci.
“But in 2020, Fannie Mae upped its maximum acceptable DTI to 50 percent, giving overextended borrowers more breathing room.”
These higher DTI allowances can be a big help for borrowers with lower income and/or high debt levels (for example, those with hefty student loan payments).
However, you also have to consider the implications of maxing out your DTI.
Getting approved with a 50% DTI means half your monthly pre-tax income is going toward your mortgage and other debts. That number will feel even higher after taxes are taken out.
You might decide qualifying with the maximum DTI makes sense for you. But if not, remember you don’t have to use the full allowance. The most important thing is to have a housing payment and monthly budget you’re comfortable with.
Debt-to-income requirements vary by loan program
Keep in mind that every loan can have different DTI ratio maximum limits, according to Martucci and Dave Cook, loan officer with Cherry Creek Mortgage.
Typically, the maximum DTI for each of the major loan programs is as follows:
- Conventional loans (backed by Fannie Mae and Freddie Mac): Max DTI of 45% to 50%
- FHA loans: Max DTI of 50%
- VA loans: No maximum DTI specified, although VA loan applicants with higher DTIs could be subject to additional scrutiny
- USDA loans: Max DTI of 41% to 46%
- Jumbo loans: Max DTI of 43%
“In general, borrowers should have a total monthly debt to income ratio of 43 percent or less to be eligible to be purchased, guaranteed, or insured by the VA, USDA, Fannie Mae, Freddie Mac, and FHA,” Maxwell adds.
“But if borrowers meet certain product requirements, they may be allowed to have a DTI ratio higher than 43 percent.”
How to qualify with a high DTI
If you have a DTI above 43%, you may find it more difficult to qualify for a mortgage loan. And if you are approved, your loan may be subject to additional underwriting that can result in a longer closing time.
Overall, higher DTI ratios are considered a greater risk when an underwriter reviews a mortgage loan for approval.
“In some cases, if the DTI is deemed too high, the lender will require other compensating factors to approve the loan,” explains DiBugnara.
He says compensating factors can include:
- Additional savings or reserves
- Proof of on-time payment history on utility bills or rent
- A letter of explanation to show how an applicant will be able to make [mortgage] payments
A higher credit score or bigger down payment could also help you qualify.
Cook notes that, for conventional, FHA, and VA loans, your DTI ratio is basically a pass/fail test that shouldn’t affect the interest rate you qualify for.
“But if you are making a down payment of less than 20 percent with a conventional loan, which will require you to pay mortgage insurance, your DTI ratio can affect the cost of that mortgage insurance,” adds Cook.
In other words, the higher your DTI, the higher your private mortgage insurance (PMI) rates.
How to calculate your DTI
To determine your debt-to-income ratio (also called your “back-end ratio”), start by adding up all your monthly debt payments.
Monthly debts for DTI include:
- Future mortgage payments on the home you want (an estimate is fine*)
- Auto loan payments
- Student loan payments
- Personal loan payments
- Debt consolidation loan payments
- Any other installment loans you pay monthly
- Credit cards payments and other revolving credit lines (use your minimum monthly payment)
- Child support
*When estimating your monthly mortgage payment to calculate DTI, make sure it includes property taxes and homeowners insurance. You can use a mortgage calculator with taxes, insurance, and PMI to see your ‘real’ payment
Your DTI calculation should NOT include:
- Rent payments
- Cell phone bill
- Internet bills
- Other non-debt expenses that don’t appear on your credit report
Next, divide the sum of your debts by your ‘unadjusted gross monthly income.’ This is the amount you earn every month before taxes and other deductions are taken out — otherwise known as your ‘pre-tax income.’
Then, multiply that figure by 100.
(Sum of Monthly Debts / Pre-Tax Monthly Income) * 100 = Your DTI
For example, say your monthly debt expenses equal $3,000. Assume your gross monthly income is $7,000.
$3,000 ÷ $7,000 = 0.428 x 100 = 42.8
In this case, your debt-to-income ratio is 42.8% — just within the 43% limit most lender will allow.
Front-end DTI vs. back-end DTI
Note that lenders will examine your DTI’s front-end ratio and back-end ratio.
“Your front-end ratio simply looks at your total mortgage payment divided by your monthly gross income,” says Cook.
Most lenders want to see a front-end ratio no higher than 28%. That means your housing expenses — including principal, interest, property taxes, and homeowners insurance — takes up no more than 28% of your gross monthly income.
“But in most cases,” says Cook, “the front-end debt ratio is not the number that matters most in underwriting. Most loan underwriting programs today primarily look at the back-end debt ratio.”
Tips to keep your debt-to-income ratio low for mortgage qualifying
Are you worried that your debt-to-income ratio will make you ineligible for a mortgage loan?
You can follow these tips to lower your DTI and improve your chances of mortgage approval:
- Consult with one or more lenders before applying for a loan. “Get their advice on your housing payment amount and what debt ratio caps will apply for the loan product you choose,” suggests Cook. “Ask for your best plan of action to manage your debt”
- Do your homework. “Have a solid understanding of how your DTI ratio affects your ability to get a mortgage. And understand your financial goals as well as specific debts that can be paid off to achieve those goals,” Maxwell recommends
- Lower your monthly debt obligations. “Temporarily prioritize debt payments over savings and investment account contributions, other than any employer-sponsored plan contributions you must make to qualify for your employer match. Throw as much money as you can at smaller debt balances that you can zero out quickly,” Martucci advises. “Eliminating these payments and accounts will reduce your DTI ratio”
- Avoid overusing your credit cards and racking up balances. Pay your monthly credit card debt in full instead of making only the minimum payment. Keeping your ‘credit utilization ratio’ low —minimizing your balance compared to your overall credit card limits — can lower your DTI and improve your credit score, a double whammy on your loan application
- Don’t take out any new loans before buying a house. Taking on new debt, like a car loan, increases your DTI. This can seriously reduce your home buying budget. So if possible, you want to avoid taking on any new monthly payments in the year(s) leading up to your home purchase
Even if your DTI is within the ‘good’ range for mortgage qualifying, it doesn’t hurt to try to lower it before you apply.
The lower your existing debts, the more you’ll be able to spend on your mortgage.
Working to improve your debt-to-income ratio before you apply for a home loan can make you eligibile for a bigger, more expensive home.
Check your mortgage eligibility
Estimating your DTI can help you figure out whether you’ll qualify for a mortgage and how much home you might be able to afford.
But any number you come up with on your own is just an estimate. Your mortgage lender gets the final say on your DTI and home buying budget.
When you’re ready to get serious about shopping for a new home, you’ll need a mortgage pre-approval to verify your eligibility and budget. You can get started right here.