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Debt to Income Ratio Info for Home Loans

Home Refinance Advisors help educate consumers on underwriting guidelines like debt to income ratios.

How Debt to Income Ratio Is Calculated for Home Loans

Your debt-to-income ratio (DTI), also known simply as debt ratio, is a personal finance measure that compares the amount of money that you earn to the amount of money that you owe to your creditors. It's a snapshot of your spending habits. There are two types of DTI ratios: the front-end DTI ratio, which is the percentage of your monthly gross income applied to paying only housing costs and the back-end DTI ratio, which is the percentage of your monthly gross income applied to all your debt. If your "DTI" is too high you may need a bad credit refinance loan.

When considering you for a loan, lenders typically use both use your front-end and back-end debt-to-income ratio to gauge your ability to repay debt. Before you shop for a loan, you should get your credit reports and check them for errors because your FICO credit score is another major factor in the lending decision. And, you should also calculate your debt-to-income ratio. Here's how to do it:

  1. Add up your total gross monthly income (income before taxes), including your wages, any overtime, commissions and guaranteed bonuses. If you're paid every other week, your monthly gross income is your gross income from one paycheck times 2.17. If you get alimony or child support, add that as well. You can also add any retirement or disability pension you get. If your income varies, figure the monthly average for the past two years. Don't forget to add in any income you get from rentals or any other income you regularly get. If your bonuses are annual, divide by 12 to get the monthly bonus amount.

  2. Add up your total monthly debts, including all your minimum credit card payments, auto loans, personal loans and mortgage (or rent) payment.

  3. Divide your total monthly debts by your total monthly income, and you get your debt-to-income ratio.

  4. The lower your debt-to-income is the better. If you're looking for a home purchase loan or a refinance loan, your debt-to-income ratio should not exceed 36. Otherwise, you may not qualify.

Here's the debt-to-income ratio formula:
Total Monthly Debt Payments Total Monthly Income = Debt to Income Ratio

So, what is considered a good debt-to-income ratio?

A debt-to-income ratio of less than 30% is considered to be excellent. If your debt-to-income ratio is 30-36%, you shouldn't have a problem getting a loan. You're in good shape. 36-40% is considered borderline. If your debt-to-income ratio is over 40%, chances are you won't qualify for the loan. A debt-to-income ratio of 41-49% indicates that financial trouble is imminent. And, if you're over 50%, you need professional credit counseling services to knock your debts down.

To qualify for a FHA loan, your front end ratio should not exceed 29%. For a conventional mortgage, a comfortable ratio is 33%. With conventional lenders tightening their standards, you may not qualify if your DTI ratio is more than 35-38%. For a FHA loan the back end DTI ratio requirement is 41% and 45% for a conventional mortgage.

Why You Should Keep Track of Your DTI Ratio

Keeping track of your debt-to-income ratio can help you avoid "creeping indebtedness," or the gradual rising of debt. Impulse buying and routine use of credit cards for small, daily purchases can easily result in unmanageable debt.