How Debt-to-Income Ratio (DTI) Impacts Your Homebuying Budget

Debt can seem like that big red “Road Closed” sign when you’re dreaming of buying a home. However, it doesn’t have to stop you. You just need to understand the limits of what your debt load can be and still be able to buy what home you want. 

One of the most important numbers lenders care about is your debt-to-income ratio (DTI). I won't mince words about it – it’s a critical number, but you can tilt those numbers in your favor.

What is debt-to-income ratio (DTI)?

You’ll need to compare your monthly debt to what you make each month before taxes (your gross monthly income). If you and your spouse are looking to purchase together, include your spouse’s debts and both your incomes.  Monthly debt includes credit cards, car payments, student loans, personal loans—anything with a monthly bill. I’ll talk about how to use those numbers to figure out your DTI later in the article.

Utilities like electric, water, gas, internet, trash—are considered living expenses, not debt. Lenders know you’ll still have them, but they don’t factor them into the DTI formula. That said, you should factor utilities into your personal budget so you know what you can comfortably afford each month. A lender might approve you for a payment that feels fine on paper but gets tight once you add in electric, heat, and Wi-Fi.

The lower your DTI the less you’ll be seen as a risk to the lender. What it means for them is they will carry lower risk, which translates into more attractive interest rates and higher borrowing limits for you.

What’s A Good DTI Ratio For Buying A Home?

There's no one set percentage since it matters towards the type of loan you want to use to purchase your home.  Ideally, you should shoot for a DTO of:

 💸Under 50% for a Conventional loan

💸Up to 56.9% for an FHA loan, and

💸VA loans don’t really have a limit.

Keep in mind your credit and the type of income you have will play a part in the decision-making process, too.  However, if you don’t meet these thresholds, don’t worry.  Sometimes, you can be over the limits and still qualify for the loan if your financial situation is strong. Working with a strong lender can be very helpful.

Why Does DTI Matter for Buying a Home?

A high DTI could mean you won’t be able to afford a higher priced home without putting a huge strain on your budget.  Down the road, this can lead to defaulting on the loan leading to foreclosure.  Your lender doesn’t want to risk you defaulting on the loan, so they use the DTI to help them decide it the loan is affordable to you.  A higher DTI could also translate into a higher interest rate, leading to a higher monthly mortgage payment.  This would put too much of a strain on an already stretched budget.

Debts that Make it Harder for You to Get Financing

💳Credit card payments

🚙Car loans or leases

🎓Student loans (Yes — even if you’re in deferment and not paying on that student loan yet, it holds a place in your DTI.)

🏦Personal loan or line of credit

🛋️Buy Now – Pay Later

How to calculate your DTI

Total up your monthly debt payments.

Total up your gross monthly income.

Divide your monthly debt payments by your total gross monthly income.

Multiply the answer by 100. That answer will be your DTI percentage.

For example, let’s say your total monthly income is $5,000 and your total monthly debt is $2,350.

2350 divided by 5000 is 0.47

0.47 multiplied by 100 is 47

Your DTI is 47%

Reduce your DTI (so you can purchase more or get the home you want)

Sometimes hearing you need to reduce your debt doesn’t help.  Regardless, we still have our bills to pay leaving little money to put towards paying down debt.  Every little bit helps, though.  You can also stop using the credit cards altogether, so your debt doesn’t continue to increase.  Start by paying off the high-interest credit cards and keep going until you get to the lowest rate card.  Don’t worry about which one has the highest balance.  Pay the minimum due on the other cards until you get the highest rate card paid off and then go to the next highest rate card.

Of course, earning more money through a second job or side business can work to reduce your DTI.  If your current job doesn’t give you that time option, then take a look at the type of home you want to purchase.  Yes, it may not have the new appliances and fresh paint, but those things can always be added later.  Lowering the amount you’ll be borrowing can make a difference in loan qualification even if your DTI is a little high and your finances are in good order.

Bottom Line on DTI

So, while DTI is a major factor in the homebuying process, it is something you can actually manage. Since most of us are not purchasing with cash, the larger your down payment is, the more money you could be approved to borrow for your mortgage. Having the best DTI means a better shot at lower rates and less financial pressure on you once you close on your home. 

Thinking about buying but not sure where your DTI stands? I’ll connect you with an experienced local lender who can break down your numbers, then I’ll walk you through what they mean for your budget and buying power. Together, we’ll make sure you’re looking at homes that fit your comfort zone and your budget. Send me a quick message and we’ll get started.