Debt-to-income ratio (DTI) is one of the key factors mortgage lenders use to determine whether or not a potential borrower can afford a mortgage. The debt-to-income ratio is calculated by dividing total monthly debt payments by total monthly income. Monthly debt payments generally include expenses such as mortgage payments, auto payments, student loan payments, credit card payments, and child support payments. Monthly expenses such as utilities, auto insurance and phone services are not included towards the monthly debt calculation. Monthly gross income generally includes the borrower’s monthly income, his/her spouse’s monthly income, any savings income, and any business or side incomes.
To learn how to calculate DTI, let’s consider the following example:
Monthly Mortgage Payment: $1200
Monthly Auto Payment: $500
Credit card payment (minimum): $300
Total Monthly Debt Payment = $(1500+500+500) = $2000
Suppose the monthly incomes are as below:
Borrower’s Monthly Salary: $3500
Spouse’s Monthly Salary: $2500
Other Income: $500
Total Monthly Income= $(6000+2500+500) = $6500
Debt-to-Income Ratio = Total Monthly Debt Payment/Total Monthly Income = (2000/6500) = 30.76%
When underwriting a mortgage, a lender will typically consider two kinds of debt-to-income ratios. First is the front ratio, which includes all housing costs (i.e. mortgage principal, interest, mortgage insurance premiums, and property taxes). The second is the back ratio, which includes non-mortgage debt such as credit card payments, auto loan payments, child support payments, and student loan payments.
As a general rule of thumb:
- Front ratio = Housing DTI: Total Monthly Housing Payment / Gross Monthly Income Before Taxes
- Back ratio = Total DTI: Total Housing Payment + Other Debts / Gross Monthly Income Before Taxes
The maximum allowable DTI to qualify for a loan is going to depend upon your lender, your financial situation, and your loan program. Underwriting standards may vary from lender to lender, so you will want to contact your lender of choice to find out how it calculates DTI for a given loan program.