Debt-to-income (DTI) ratio meaning for mortgages

You don’t need a finance degree to have money smarts. Leveling up your knowledge of loan requirements could help you lead your best financial life. One term to know is DTI, or debt-to-income ratio. Lenders use DTI to determine whether you can afford the loan you want. Home equity loans and home equity lines of credit (HELOCs) are mortgages, and here’s how your DTI could affect your eligibility for a mortgage.

Definition of DTI (debt-to-income ratio)

DTI, or debt-to-income ratio, is the percentage of your pretax income that goes to debt, housing, and other legal financial obligations. A low DTI means your debt level is affordable. A high DTI means there’s less wiggle room in your budget because your money is already spoken for. Each lender has its own acceptable DTI, but generally, the lower the better. 

Understanding your DTI could give you an edge when shopping for a loan.

How to calculate DTI

Here’s how it’s done in two steps:

1. Add up your housing payment and the minimum monthly payments for each debt, including car loans, personal loans, student loans, and credit cards. Add any child support or spousal support payments you have to make, as well as other debts you’re paying off. Don’t include other bills or expenses.

2. Divide the total by your monthly income. For example, if your monthly income is $5,000 and your debts and housing amount to $2,000, divide $2,000 by $5,000 ($2,000 ÷ $5,000 = 0.40). Your DTI is 40% in this case. 

There are a few rules:

• The income you’ll use is your total before-tax income, not your take-home pay. To be counted, income must be ongoing and reliable.

• Don’t include every bill. General living expenses like food, income taxes, utilities, fuel, and childcare don’t count toward your DTI. 

• Do include the minimum payments on your credit cards.

• Don’t include extra—but optional—payments you make toward your debts.

• Do include housing costs. If you rent, it’s your rent. If you own, it’s your mortgage payment, including principal, interest, taxes, insurance, and homeowners association (HOA) dues. 

• Do include the required monthly payments on your loans. Include car loans, personal loans, student loans, and other debts you’re paying off. If you are legally obligated to pay child support or spousal support, include those as well (but the lender might not consider these payments if they’re due to end soon).

DTI and your credit score

DTI doesn’t affect your credit score, and your credit score doesn’t influence your DTI. Your credit score is based on:

• Your payment history

• Amounts owed

• Account age

• Credit mix

• Hard inquiries (the kind that happen when you apply for credit)

That said, both DTI and credit score are measures of financial health, and they often go hand in hand. 

For example, if your credit card balances are high and you can only afford to make minimum payments, chances are good that your credit score has taken a hit and you have a high DTI. 

On the flip side, if you have a low DTI, that could mean that you are living below your means and avoiding excessive debt. It would be great if these qualities were rewarded with high credit scores, but they aren’t. To have good credit, you need to have and use credit accounts. If you avoid debt, you might not even have a credit score, even with a great DTI.

DTI examples for home equity

DTI for a home equity loan is the lender’s cutoff for how much debt you can already have and still be approved. It includes the payment on the new home equity loan that you want. Some lenders may want you to have a DTI under 43%. Other lenders may allow a higher home equity loan DTI.

Luke earns $78,000 a year ($6,500 per month) and owns his home. His mortgage payment includes $1,100 for principal and interest, plus $140 for property taxes and $60 for homeowner’s insurance (total payment: $1,300). He also has a $300 car payment. Luke wants a $100,000 20-year home equity loan for some renovations. He qualifies for an 11.5% APR. The monthly payment will be $1,078. 

This home equity loan example is for informational purposes only. The payment is calculated using the Actual 360 interest calculation method. Interest rate and payments are for illustration only. Individual results vary.  

Here’s Luke’s DTI:

Most home equity lenders will consider Luke’s DTI to be within the acceptable range to qualify for a new loan. 

Why is DTI important?

DTI isn’t just important to lenders. It matters even more to you. Your DTI is a snapshot of how doable your lifestyle is at any given time. 

What is a low DTI?

Most lenders consider 36% or lower to be very healthy, and of course, lower is always better. 

When you apply for a loan, lenders love a low DTI because it shows that there’s money in your budget that could cover a new loan payment. That’s why having a lower DTI could improve your chances for loan approval. In some situations, a low DTI could help you land a lower interest rate on the loan you want.

A low DTI isn’t just about loan applications, though. It’s about managing your budget. Having a low DTI makes it easier to afford your current financial obligations, with money left over for household expenses, savings, unexpected costs, and (yay) some fun. 

What is a high DTI?

Anything over 43% is considered relatively high. That’s a limit used by many mainstream lenders. People do get loans with a DTI over 43%, and even over 50%, based on the overall strength of their finances and the type of loan they’re after.  

Still, a high DTI could make it harder to borrow. Or it could make it harder to borrow the amount you want, mainly because the lender may think you’d have a hard time affording the payment. 

A higher DTI can also lead to more expensive loans. Because a higher DTI represents a higher risk to lenders, they may charge you more to compensate for that risk. If you have a high DTI, the lender may ask for other evidence of financial stability before approving your loan.

It’s not always a dealbreaker if your DTI is on the high side, but it’s something to watch, and something you may want to work on. Even if you don’t plan to apply for new credit any time soon, a high DTI means most of your money is already spoken for. That leaves you less to save, invest, and spend on necessities. Bringing your DTI down means making more of your money available to spend or save the way you choose to.

DTI and home loans

DTI for a HELOC or home equity loan is the percentage of your income used for monthly debt payments, including the new credit line you want. Your lender might require that you have a DTI under 43% to get approved for a HELOC. Some lenders allow higher DTIs, especially if your application is stronger in other areas. For example, if you'll still have a lot of home equity after getting a HELOC, the lender might be more flexible on its DTI requirement.

Your housing DTI is also called your “front-end DTI.” It’s the portion of your income that goes toward housing. It includes your mortgage principal and interest payment, property taxes, homeowners insurance, and any HOA dues. If you rent, it just includes your rent. A low housing DTI shows there’s room in your budget to potentially take on a new payment.  

If your DTI is higher than 43%, the best thing to do is talk to a mortgage advisor who can help you learn about your options. 

Tips for improving DTI and increasing loan eligibility

There are several ways to improve your DTI. Generally, they fall into one of these three categories:

• Lower your monthly debt payment by consolidating or refinancing your debts

• Pay down your debt

• Increase your income

Debt consolidation: The way debt consolidation works is that you take one new loan and use it to pay off more than one smaller debt. This could lower your DTI if the consolidation loan has a lower payment than the loans it replaces. You could reduce what you pay each month if you get a loan with a lower interest rate and/or a longer repayment term. Debt consolidation doesn’t get rid of any of your debts. It only moves your debt from one place to another.

Debt refinancing: Refinancing a loan means replacing it with a new one. People do this when the new loan has a lower interest rate, lower payments, or some other benefit. If your new loan has a lower payment, this reduces your DTI.

Increase your income: A great way to reduce DTI is to offset your debt expenses with more income. More income could ease financial stress, too. Consider picking up another job or side hustle or exploring other ways to generate more income.

Pay down debt: This is the long-haul plan that could improve your DTI without taking on a new loan. To pay off your balances over time, you need to be mindful about spending, so start by looking at your budget and setting goals, aiming to reduce costs and put more toward your debts. 

Once you’ve got your plan in place, make it stick. Check your balances and DTI every month. Do your best to stay on track and don’t forget to celebrate your progress. Use an app to help you. The Achieve MoLO app tracks your income and expenses to help you find ways to end up with more money left over at the end of the month. That could help you pay down your debt faster.

At the end of the day, DTI is a measure of your financial comfort level. If your DTI is on the high side, consider what you could do with more money freed up each month. Setting your sights on specific priorities can help motivate you to work toward a lower DTI.