The Real Story on Debt-To-Income (DTI) Ratios as Told by a Mortgage Loan Officer

The math is easy. To find your debt-to-income ratio, or DTI, for a mortgage just divide your debt payments by your gross monthly income (your income before taxes and deductions). Then multiply the answer by 100.

A borrower with monthly debt of $2,000 and a gross monthly income of $5,000 would do this equation:

$2,000 monthly debt ÷ $5,000 gross monthly income x 100 = 40 percent DTI

What’s not so easy is knowing which numbers to put in those two slots. Not all income qualifies. Debt can be tricky, too. For example, what about deferred student loans? What about those new payment apps online retailers are using?

Let’s look closely at DTI to answer these and other questions.

What is Debt-to-Income Ratio?

Nobody should buy a house that stretches their monthly budget too thin. That’s bad for borrowers and lenders.

DTI gives us a way to estimate, in advance, whether a mortgage applicant will be able to afford the new loan’s monthly payments.

Front-end DTI vs back-end DTI

We use two types of DTI to measure the borrower’s ability to afford the new loan’s payment: Front-end DTI and back-end DTI. These are two different buckets, but your mortgage application will have to fit into both:

• Front-end DTI: This shows how much of your monthly income you’ll need to make the new house payment

• Back-end DTI: This shows how much of your monthly income goes toward all your debt, including the new house payment

Why do we need two types of DTI? Because the two numbers together give us a fuller picture of the borrower’s financial life.

For example, if we used only back-end DTI, a borrower who has five credit cards could pay down all those balances, lowering DTI to qualify for a more expensive home.

Then, after closing on the home, this new homeowner might run those credit card balances back up and no longer be able to afford the home. Adding the front-end DTI rule puts a second cap on the loan size, helping us keep borrowers out of these kinds of predicaments.

After all, the end goal is sustainable homeownership for the buyer, not just to close a transaction.

Why DTI Is Important for Homebuyers & Mistakes People Make

Borrowers must satisfy their loan’s DTI rules to get approved and buy the home. For this reason alone, DTI is important.

But it’s a mistake to treat DTI like a temporary hurdle to jump over and forget about. For example, if I say you need to eliminate $1,000 worth of debt payments to get approved for the home you’re looking at, am I really doing you a favor?

Not if you normally carry that $1,000 in debt payments and will add them back after closing on the home. I’d rather know what you’re really doing in your financial life so I can help plan for a house payment that matches your financial reality.

This reality matters for both the debt and the income in the DTI equation. For example, borrowers shouldn’t take on a second job, inflating their earnings temporarily, just to qualify for a bigger mortgage.

This goal — to get an honest picture of the borrower’s ability to make the house payments — helps set our rules about what counts as debt and income.

What Counts As Debt in DTI

Obviously, monthly payments on auto loans, personal loans, student loans, and revolving loans like credit cards count toward debt.

Loans you’ve cosigned will also count toward your debt. This is true even if the person you cosigned for is making the payments without your help. It doesn’t matter. You’re still responsible for the debt.

I’ve had borrowers cosign on a car loan before closing and it killed the deal. If you’ll be in the market for a home in coming years, don’t cosign.

Sometimes we can exclude installment loans from DTI. If the loan has less than 10 payments remaining — and if the payment amount is less than five percent of your gross monthly income — we can exclude that payment.

Both of those rules have to be met to exclude this payment.

Example:

• $5,000 in qualifying income

• The car payment would have to be $250 or less to meet the five percent rule.

What About Deferred Student Loans and Pay-Later Debts?

Other types of debt can be harder to count. With deferred student loans, for example, we can’t enter your payment as $0, even if you aren’t making payments now, because your student loan payment won’t be $0 throughout the 30-year term of your mortgage.

Instead, we enter half a percent of the loan balance, but this can be has high as one percent of the balance for some loan types. If you owe $20,000 in student debt, half of one percent is $100 and one percent is $200. Not usually a huge deal. But for people with advanced degrees who have $200,000 in deferred debt, half a percent is $1,000 a month. That can be a deal breaker.

BNPL Loans

And about those new buy-now, pay-later (BNPL) programs that online retailers offer: They can wreck your DTI. These are revolving debts, not installment debts, so they will always count toward debt, even if you have only one payment left.

Be sure to get any and all buy-now, pay-later accounts paid off before applying for a mortgage. Otherwise, your last Amazon purchase could derail your plans to buy a house.

What About Utilities, Groceries, Gas, and Other Living Expenses?

Only debt payments factor into debt-to-income ratio, so money spent on transportation, dining out, groceries, streaming services, concert tickets, collectibles, school supplies, clothes, and household items won’t count, as long as you don’t convert these expenses into debt by parking them on a credit card.

What Counts as Income in DTI

For some homebuyers, documenting income is easy. For instance, someone who’s had the same steady, 40-hour-a-week job for the past two years can show their W2 forms or pay stubs and all of their gross income should qualify.

But overtime pay, bonuses, income from side hustles, self-employment income — this income is harder to qualify. Why? Again, it’s all about getting a true picture of future income. The lender needs to know whether you can keep earning the income for years into the future.

Maybe you’ve worked two full-time jobs for the past year and now you can document the income needed for a bigger mortgage? That’s quite an accomplishment. But can you keep this up for 30 more years? Most people can’t, and lenders know this. All of this income probably won’t qualify.

This is also the problem with overtime pay and bonuses. Earning them in the past doesn’t mean they’ll be available to earn in the future. Qualifying income, ultimately, means stable, predictable, and dependable income.

The Self-Employment Income Problem

Borrowers who earn most of their money through self-employment can face a DTI dilemma.

It’s not the source of the income that causes the problem. Income from self-employment qualifies for a mortgage as long as it shows up on the borrower’s last two income tax returns. (These borrowers may also need to show a profit-and-loss statement from the current year.)

The problem comes from how self-employed borrowers file their income taxes. Most deduct expenses to lower their taxable income, lowering their income tax bill for the year.

Along with lowering the tax bill, deducting expenses also lowers qualifying income for a mortgage.

Self-employed homebuyers should tell their loan officer about their source of income. Ideally, they should tell their accountant they’re planning to apply for a mortgage a couple years before they apply. They may be able to time big expenses and avoid unnecessary deductions.

How to Improve DTI Before Applying

Ultimately, DTI goes down when income goes up, or when debts go down, or when both happen.

Borrowers can and should improve their DTI before applying for a mortgage, but be wary of one-size-fits-all solutions. In fact, a lot of the DTI tips you see online can get you into trouble.

How to Increase Income for DTI

My first piece of advice is to show up for work every day. Work your full work schedule each week. Leaving a few hours early on Friday may not sink your next paycheck, but making this a habit will hurt your DTI.

Instead of thinking about making extra money, think about creating a bigger and more stable income. From this point of view, getting a raise would be better than getting a bonus or asking for overtime.

Part-time jobs and side hustles might help, but this income might not qualify. You have to have two years’ history of side income while working your primary job for it to count. Most applicants just can’t show this history.

To qualify as mortgage income, a source of income should be sustainable, and it must be documented. For people who earn tips, this means reporting cash tips to employers.

How to Reduce Debt for DTI

In general, avoid opening new debt accounts in the months before applying for a mortgage. Definitely don’t open any new accounts after applying. This includes the buy-now, pay-later plans. (Think Klarna, Affirm, Pay in 4, etc.)

DTI counts monthly debt payments — not the debt itself. Paying off installment loans and keeping credit card balances low should reduce debt payments while also lowering debt.

But consolidating loans or refinancing them to get lower monthly payments could also help decrease DTI without necessarily reducing the debt itself.

For example, a $50,000 balance with a $500 monthly payment is better than a $20,000 balance with a $1,000 payment, at least as far as mortgage qualification goes.

I’ve worked with people who had a really high car payment because they’d financed it for two years instead of four or five. We talked about getting it refinanced to fit their budget. This feels kind of gimmicky, but your monthly budget is what matters. After the auto loan refinance, the borrower still had the same amount of debt and the same car, so the refinance was a sustainable change.

But be careful with this. Always check with your loan officer first before taking steps. These kinds of changes can have a negative effect on a loan file, undermining any help they give to DTI. Let us run the math before you’re on the hook for it.

Co-borrowers Can Help and Hurt DTI

People who will live together in the new home can usually benefit from making a joint mortgage application, especially when both applicants earn income and share most of the same debt.

Sometimes, if one borrower holds most of the household debt and earns a smaller share of the household income, it’s better to have only the stronger of the two applicants on the file. (This won’t help in the nine community property states where married couples share each other’s debts.)

Sometimes borrowers want to add a co-borrower who won’t live in the home to boost qualifying income. This can help, but along with their income, co-borrowers also bring more debt. A co-borrower who brings mortgage debt of their own may hurt DTI more than they help it.

Related: The Risks and Benefits of Co-Signing a Mortgage

Overcoming High DTI

DTI is a big part of your mortgage eligibility, but it’s not the only piece of the puzzle.

Some borrowers with higher DTIs can still get approved, even if the loan must be underwritten manually. When DTI is weak, it helps to have other strengths in your loan file.

Residual income can help here. Not every 50 percent DTI looks the same. Someone who earns $20,000 a month and pays $10,000 toward debt has a DTI of 50 percent, which is higher than ideal. But they also have $10,000 a month left over for living expenses.

This is a lot different than earning $4,000 a month and paying $2,000 toward debt. With only $2,000 left for living expenses, this 50 percent DTI borrower may be one unexpected car repair away from falling behind on the mortgage.

Higher DTI borrowers also look better to lenders when they have:

• A strong credit history

• A larger down payment

• A large savings account balance

These are called compensating factors. When higher DTIs make the lender take a second look, these compensating factors can shore up the loan file.

What’s a Good DTI Ratio?

Here are some typical DTI numbers to keep in mind:

Next Steps for Borrowers

To clear your new home’s DTI hurdle, get started a couple of years before you apply for a loan. Start with the simple things:

• Earn sustainable, steady income

• Keep credit card balances low, avoid unnecessary borrowing, don’t co-sign for anybody, pay off those buy-now, pay-later apps before applying

Then find a good loan officer who will be honest with you about what is and isn’t possible. Banks like the simplicity of hard numbers, but mortgage borrowing also includes nuance. Every borrower’s situation is different and should be treated that way.

If you’re not getting individual attention from your loan officer, find another one who has the time and interest to study your case and be honest about your best options.

One Last Note: Keep DTI in Perspective

Obviously DTI is very, very important, but you shouldn’t miss out on a great house over the difference between 33 and 30 for front-end DTI. Instead, calculate a budget. If you feel confident you can make the monthly payment — and the lender will approve the loan — then do it.

Recently, I had a client approved for a good loan but they didn’t want to go past 25 percent front-end DTI, which is a common piece of personal finance advice you might see online. I did the math, and ran their current rent with the proposed house payment side by side. I said the 25 percent DTI is what you’re paying for rent right now. And you’re not seeing any benefit from home appreciation.

Something clicked, and this client could see beyond the simple DTI math. The client realized personal finances keep changing after the mortgage closes. Most people earn more money today than they earned 10 or 15 years ago. As income grows, the new mortgage payment will become a smaller part of your monthly budget. In a few years you might hit that ideal DTI threshold, especially if you stay responsible and limit consumer debt.

This can happen even though your house payment will probably increase, too, because your homeowners insurance premiums and property taxes are part of the payment, and they tend to go up every few years.

Most importantly, home values, historically, have increased in the long run even when they decrease for a few years at a time. The house you buy for $300,000 today could be worth $350,000 or more in 5 or 10 years.

My client who didn’t want to exceed 25 percent DTI weighed the options and decided to go ahead with the loan. A year later, they’re very happy with the decision.

If you’re ready to take the next step, start by seeing what you may qualify for here.