Debt to Income Ratio Calculator

Understanding Your Debt to Income Ratio

You may have heard of debt in income ratio, but do you know what it is or how it can affect you? Did you know that there is both front and back end debt to income ratios? If the answer is no, this article will explain this concept. We will also talk about what is considered a high ratio, along with a few steps you can take to lower your debt to income ratio.

What is Debt to Income Ratio and Why is it Important?

Your debt to income ratio (DTI) is a tool that banks and financial institutions use along with your payment history, to decide if you can afford to make payments on a loan or a line of credit before they extend it to you. Simply put, it is your monthly debt payment amount divided by your monthly gross income. This is important because your income amount can be deceptive, and it is difficult for a bank to tell just by looking at it.

Say you make $8,000 each month in income, could you afford a car payment that will be $600 each month? If someone looked at your income, they'd say yes; you could afford it with no problem. However, what they don't know is that you have a $7,600 mortgage payment each month. Once you bring that factor in, the answer changes to no, you can't afford the car. Banks and lenders are aware of this, and this is where your debt to income ratio comes into play. The DTI equation looks like this:

Debt Payments / Monthly Gross Income = Debt to Income Ratio

If your gross income (amount before taxes or deductions) is $8,000 and your debt payments are $2,100 each month, your debt to income ratio would be 26%. Your potential lender doesn't want to see a high DTI because this makes you a higher risk for not being able to afford the monthly payments, and it is a sign of a stressed financial situation.

What is a Front End Debt to Income Ratio?

Your front end ratio focuses solely on how much of your monthly gross income goes toward housing expenses, and it is more commonly known as your mortgage to income ratio. This variation of the DTI looks at expenses like housing insurance, mortgage payments, and property taxes. For example, if your monthly mortgage payment is $1,000 each month including property taxes and insurance, and your monthly income is $4,000 per month, your front end DTI would be 25%.

Front End DTI Limits

The standard maximum front end DTI that most lenders will accept is 28%. When you go and apply for a new loan, and you bring a 20% down payment, the lender will usually approve you for the loan if it doesn't exceed the 28% limit. If we assume that you have a monthly gross income of $4,000, the maximum mortgage payment you would be paying each month is $1,120. If you use the FHA loan program to obtain a mortgage, they typically use a 29% maximum DTI ratio with a down payment of 3.5%. This is reserved for moderate or low-income applicants.

What is Back End Debt to Income Ratio?

Your back end ratio is a variation of the standard ratio that looks at all of your monthly debt against your gross income. Along with your mortgage payment, it also factors in any personal loans, auto loans, and credit card payments you make each month to see how much additional debt you can comfortably afford. If you have a monthly gross income of $4,000 and you pay $1,400 in debt obligations, your back end ratio is 35%. This level will put you right at the maximum limit that is accepted by lenders.

Back End DTI Limits

The standard maximum limit most traditional lenders will accept with the back end DTI is 36% with regular loans and 43% of loans through the FHA. This is done to protect the bank, as it will cover your payments if you stop paying and default. If you have a $4,000 monthly income, $1,440 would be the 36% maximum. This figure means that all of your monthly debt payments can't go over this $1,440 limit. So if your mortgage is $1,000 per month, your other loans can't exceed $440.

What is Considered a High Debt to Income Ratio?

Depending on which ratio you're considering, there are separate limits for each of them. In general, you want to keep this number as low as possible because it is a good indicator of how you are doing financially. If you have a 60% debt to income ratio, any added expense could leave you scrambling to pay everything on time. If you have to start paying more on something like unexpected medical expenses, you'd have a harder time than someone who has a 25% debt to income ratio.

Debt to Income Ratio Limits

	Low Ratio	Medial Ratio	High Ratio
Front End Debt to Income	15%	20%	28%
Back End Debt to Income	21%	30%	36%

Your lenders will look at all of your DTI ratios and decide if they think you can make the additional payments or not, so it is generally a good idea to keep this limit as low as you possibly can. You're more likely to get approved for the line of credit you're asking for this way.

How Can You Lower Your DTI Ratio?

Once you know where your debt to income ratio is at, you can work to lower it in a variety of ways. Not only will lenders be more willing to work with you, but you'll be more financially secure and able to handle any unexpected expenses that may come your way.

Pay Off Any Revolving Accounts

If you have credit card balances that have slowly crept upward over the years, focus on paying those down as quickly as you can. If you carry balances from month to month, you're hurting your financial bottom line by paying more in interest over the life of your credit cards.

Cut Out Unnecessary Expenses

If you look at your monthly expenses and notice that a decent portion of your income is going to something you can live without, try to cut it out of your budget. You can cut back on eating out each month, or you can skip that $3.00 cup of coffee each morning and make your own. If you buy lunch each day, pack one and bring it from home. Take the money you save from these steps and use it to pay on your existing debt.

Ask for a Raise

If you haven't gotten a raise at your job recently and you think your skill set is sufficient, schedule an appointment to meet with your boss and explain why you think you deserve a raise. It may only be a few cents more an hour, but that will add up, and if you see any higher paying open positions at your work that you'd think would be a good fit, apply for them.

Get a Part Time Job

Check your local businesses and see if anyone is hiring on a part time basis. You could even find a job that works around your current schedule and wants workers in the evenings or on the weekends. Even if you only work two or three days a week, this would be more money coming in every two weeks than you currently have. Take this extra money and use it to pay down your debts until they're completely paid off.

Reduce Your Student Loan Payment Amount

You want to pay these off as quickly as you can, but getting each balance to zero in the next year or two years probably isn't feasible. Contact your student loan lender and ask if they can reduce your monthly payments. When lenders calculate your debt to income ratio, they look at the minimum payment you have to make. So, if you get your payment reduced from $400 to $200, your debt to income ratio will improve. You should continue to pay the full amount each month to pay them off quicker, no matter what the actual payment amount is.