If you’ve recently been in the market for a mortgage loan, you may have come across the term “debt-to-income ratio.” This ratio is one of the many factors lenders use when considering you for a loan.

What is a debt-to-income ratio (DTI)?

A debt-to-income ratio (DTI) is the percentage of your gross (pre-tax) monthly income spent on repaying regularly occurring debts, including mortgage payments, rents, insurance premiums, outstanding credit card balances, and other loans.

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There are two types of ratios that lenders evaluate, a front-end ratio and a back-end ratio. The front-end ratio is what percentage of your income would go towards housing expenses, and the back-end ratio includes the aforementioned along with other reoccurring monthly debt obligations. Living expenses, such are food and utilities are not included. For the purposes of this article, we will focus on the back-end ratio which includes all debt.

How to Calculate Debt-to-Income Ratio

In order to figure your back-end debt-to-income ratio, you need to determine your monthly gross income before taxes. This must include all sources of income you may have.Next, determine what your monthly debt payments are. If you’ve already created a budget or used a free debt management tool, this should be easy. Be sure to include credit cards, student loans, auto loans, mortgage/rent, insurance premiums, child support, and other reoccurring debt obligations.

The final step in calculating your debt-to-income ratio is to divide your total monthly debt payments by your monthly income gross. To get a percentage, move the decimal point over to the right two times.

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Here’s an example of a monthly debt-to-income ratio formula calculation:

Monthly debt total:

• Mortgage: + $1,100
• Auto loan: + $300
• Credit card payments: + $200
• Monthly debt total = $1,600

Monthly income gross:

• Mortgage: + $1,100
• Auto loan: + $300
• Credit card payments: + $200
• Monthly debt total = $1,600

Debt-to-income calculation:

1. First, divide your total debt by your total income:

• 1,600 / 4,200 = .3809

1. First, divide your total debt by your total income:

• 0.3809 x 100 = 38.09
• Calculated debt ratio = 38.09%

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What is a Back-end Good Debt-to-Income Ratio?

Generally, an acceptable debt-to-income ratio should sit at or below 36%.

Some lenders, like mortgage lenders, generally require a debt ratio of 36% or less. In the example above, the debt ratio of 38% is a bit too high. However, some loans allow for higher DTIs, please see below.

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Why is Your DTI Ratio Important?

Generally, an acceptable debt-to-income ratio should sit at or below 36%.

Some lenders, like mortgage lenders, generally require a debt ratio of 36% or less. In the example above, the debt ratio of 38% is a bit too high. However, some loans allow for higher DTIs, please see below.

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How Much Do Debt Ratios Affect a Credit Score?

Your income does not have an impact on your credit score. Therefore, your DTI does not affect your credit score.

However, 30% of your credit score is based on your credit utilization rate or the amount available on your current line of credit. Generally, your utilization rate should be 30% or lower to avoid having a negative effect on your credit score. That means that in order to have a good credit score, you must have a small amount of debt and actively pay it off.

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How to Lower Debt-to-Income Ratio

The only way to bring your rate down is to pay down your debts or increase your income. Having an accurately calculated ratio will help you monitor your debts and give you a better understanding of how much debt you can afford to have.

Avoid employing short-term tricks to lower your ratio, such as getting a forbearance on your student loans or applying for too many store credit cards. These solutions are temporary and only delay repaying your current debts.

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What is the Best Debt-to-Income ratio?

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Long term, the answer is “as low as you can get it.”However, hard numbers are better tools for comparison. Take a look at the following DTI ranges:

• 36% or less = Ideal
• 37%-42% = Acceptable
• 43% = Typically the maximum for some lenders, with some exceptions up to 45%
• 50% and up = DTIs of 50% or below with FHA, but exceptions can be made for an FHA or VA mortgage

If you’re trying to get a home loan, it’s a good idea to keep your back-end DTI ratio below 43%, though 35% or less is considered “ideal.”

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Need Help to Lower Your DTI Ratio?

Your DTI is an important tool in determining your financial standing. If you’re struggling to come up with ways to lower your ratio or are looking for financial guidance, our expert coaches can help you. Contact us today to learn more about how our Debt Management Plans can help you take control of your debt payments.

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