Understanding Debt-to-Income Ratio: Why It Matters and How to Improve It
When you apply for a loan, lenders evaluate your financial health to determine whether you’re a good candidate for borrowing. Three key factors they consider are:
Credit Score: This reflects the likelihood that you’ll miss a payment in the near future.
Credit Report: A record of how responsibly you’ve managed debt over time.
Debt-to-Income Ratio (DTI): A quick measure of how much debt you can comfortably afford based on your income.
If you’re carrying significant debt, you may need to lower your DTI to improve your chances of loan approval. Understanding how DTI is calculated and ways to improve it can put you in a stronger borrowing position.
What Is Debt-to-Income (DTI) Ratio?
Your DTI ratio compares your total monthly debt payments to your gross monthly income. Lenders use this metric to assess whether you can handle additional debt while keeping up with your current obligations. Alongside your credit score and report, DTI provides a snapshot of your overall financial stability.
A high DTI can be a red flag for lenders, signaling that your debt load is already substantial. This can make it harder to qualify for new loans or credit cards, as it increases the risk of missed payments.
How to Calculate Your DTI
Before applying for a loan, calculating your DTI can give you insight into how lenders will view your financial situation. Here’s how:
Types of DTI
Front-end DTI: Includes housing-related expenses such as rent or mortgage, property taxes, homeowners insurance, and HOA fees. It does not include utilities or other personal expenses.
Back-end DTI: Includes all monthly housing costs plus additional debt payments, such as credit cards, auto loans, student loans, and personal loans.
Step-by-Step Calculation
Determine your gross monthly income (before taxes and deductions). Include wages, bonuses, side business income, pensions, Social Security, child support, or alimony.
Calculate your front-end DTI:
Monthly housing expenses ÷ Gross monthly income = Front-end DTI (%)
Calculate your back-end DTI:
(Monthly housing expenses + Monthly debt payments) ÷ Gross monthly income = Back-end DTI (%)
Example Calculation:
Gross Monthly Income: $7,000
Monthly Housing Expenses: $2,250
Additional Monthly Debt: $600
Front-end DTI: $2,250 ÷ $7,000 = 32%
Back-end DTI: ($2,250 + $600) ÷ $7,000 = 41%
What Is a Good DTI Ratio?
Lenders have different DTI requirements, but generally:
36% or less is preferred.
48% or lower is typically required for mortgage approval.
50% or higher may limit loan options.
If your DTI is too high for the loan you want, shopping around for lenders with flexible DTI limits or unconventional loan options might help.
How to Lower Your DTI
Improving your DTI involves either reducing debt or increasing income. Consider these strategies:
Pay off existing debt: If you’re close to paying off a car loan or credit card, doing so can quickly lower your DTI.
Include all sources of income: Be sure to report side jobs, bonuses, child support, pensions, or rental income.
Negotiate a raise or increase earnings: If a salary increase or overtime opportunities are available, they can improve your DTI.
Consolidate debt: A debt consolidation loan might reduce your monthly payments.
Reevaluate borrowing needs: If DTI is preventing loan approval, ask whether taking on more debt is the right move at this time.
Does DTI Affect Your Credit Score?
Unlike your credit score, DTI is not reported to credit bureaus, as income is not included in credit reports. However, high credit utilization (using too much of your available credit) can hurt your score. Paying down debt to lower credit utilization can improve both your credit score and DTI simultaneously.
As experienced mortgage brokers in Phoenix, we’ve helped countless clients navigate the home loan process and secure the best financing options. Before applying for a mortgage, take time to calculate and optimize your DTI. Along with checking your credit score and report, these steps will help you present the strongest possible financial profile to lenders—leading to better loan terms, lower interest rates, and increased borrowing power.
If you have questions about qualifying for a mortgage or improving your financial position, we’re here to help! Reach out to us anytime for expert guidance tailored to your situation.
