Calculate your debt-to-income ratio
The Debt-to-Income (DTI) ratio is calculated by dividing your total monthly debt payments by your gross monthly income. The result is expressed as a percentage. This figure helps lenders assess your ability to manage monthly payments and repay debts.
Lenders use your DTI ratio to evaluate your creditworthiness. A lower DTI indicates a good balance between debt and income, making you a more attractive candidate for loans and credit cards. It also helps you understand your own financial leverage.
A DTI of 36% or less is generally considered manageable. Between 37% and 43% is considered high, and above 43% may make it difficult to qualify for a mortgage. The lower your DTI, the better your financial health.
Increase your income through a side hustle or raise. Pay down existing debt, starting with high-interest accounts. Avoid taking on new debt before applying for a major loan. Create a budget to manage your finances more effectively.
Most mortgage lenders prefer a total DTI ratio of 36% or less, though many will approve borrowers with ratios up to 43%. Some government-backed loans like FHA loans may accept DTI ratios up to 50% with compensating factors such as a high credit score or significant cash reserves. For the best interest rates and loan terms, aim for a DTI below 36%. Conventional loans typically cap at 45% DTI.
There are two approaches: reduce debt or increase income. To reduce debt, pay down credit card balances, avoid taking on new loans, and consider consolidating high-interest debts. To increase income, negotiate a raise, take on a side job, or include additional income sources like rental income. You can also lower DTI by paying off smaller debts entirely to eliminate those monthly payments before applying for a mortgage.
Front-end DTI (also called the housing ratio) includes only housing-related costs such as mortgage payment, property taxes, homeowners insurance, and HOA fees divided by gross monthly income. Lenders typically want this below 28%. Back-end DTI includes all monthly debt obligations -- housing costs plus car loans, credit cards, student loans, and other debts. Lenders generally prefer back-end DTI below 36-43%. Both ratios are evaluated during the mortgage approval process.