How to Calculate Your Debt to Income Ratio

Why does no one talk about what a good debt-to-income ratio is when buying a home?

My name is Evan Kaufman, your VA loan originator, here to help explore the topic.

So, we have two things we’re going to go over:

1. How do you actually calculate your debt-to-income ratio?
2. What is considered a good debt-to-income ratio? I’ll also give you some of my experiences on it.

First off, how to calculate your debt-to-income ratio.

Some people assume there’s this long, complicated equation, or that the lender just tells you a random percentage and says whether you’re denied or accepted for a loan.

But it’s actually very simple.

I’ve made a nice little chart for us here, so I want you to check this out.

DTI, or debt-to-income ratio, simply means your total monthly debts divided by your total monthly income.

When we say “total monthly debts,” some people refer to it as “total monthly liabilities.”

This typically includes major installment loans, car loans, student loans, and revolving credit card debt (like a balance with a minimum payment).

You add all those up and then divide by your total monthly income.

That total monthly income is your pre-tax income from all sources. This could be a W-2 job, a business, etc.

You add that up, divide it to find out your income, and then divide those debts by that income.

For example, let’s say you have $2,500 a month in total debts. For mortgage qualification, this also includes what your future mortgage payment could be.

So, this would be your total monthly debts (e.g., student loans, car loans, credit cards, etc.) plus your anticipated mortgage debt, divided by your income.

Now, remember, we’re going to discuss what we think a good ratio is in a second.

But in this example, let’s say you have no debt at all, but your future housing payment is going to be around $2,500.

Let’s also say your pre-tax income is $5,000.

Then, your DTI would simply be $2,500 divided by $5,000, or 50%.

Another good example: Let’s say you have $3,500 in monthly debt.

You might think it’s worse because it’s higher than the previous example, right?

Well, not necessarily.

If your income is higher, let’s say your total income for the application is $10,000 (this could be individual or as a household, for example).

So, let’s say it’s you and your spouse on the application.

That total income of $10,000 means $3,500 divided by $10,000 gives you a DTI of 35%, which is actually lower, even though it’s a higher monthly debt.

Simply put, DTI is just your total monthly debts divided by your total monthly income.

For those debts, it’s not necessarily all debts out there; it’s mainly those we call installment debts or revolving credit debts.

Your cell phone bill, utilities, etc., typically aren’t going to count, so don’t worry about those.

That’s where working with your lender is important. Ideally, for our sake, we’re working with you to help understand what that number is.

Now, what is a good debt-to-income ratio?

In the examples I just gave, we had a 50% DTI and a 35% DTI. Here’s the thing: it’s a little arbitrary what is considered a good DTI for loan qualification.

There are some standards we see for conventional loans, VA loans (which we deal with a lot), and FHA loans.

Typically, for conventional loans, you usually can’t go much higher than that 50% mark—some may go slightly above, but not much.

For VA loans, we’ve seen folks with very high debt-to-income ratios because of how the VA loan is calculated.

Even though up front they say only a certain percentage is allowed, it’s calculated a bit differently using something called residual income, so it can go a lot higher.

But does that mean it’s good?

Personally, I’d argue no.

I would say the folks typically in the best financial shape are keeping that debt-to-income ratio lower.

What range would we recommend?

Try to stick around that 35% range or lower, ideally even in the high 20s.

At 35%, we typically see folks have enough margin to ensure they can invest and do other things.

Now, everyone is different — budgets can vary drastically.

Or let’s say you’re qualifying for this loan and keeping your spouse off the loan. Your debt-to-income ratio could appear really high, but remember, we’re not adding in a whole person’s income.

That’s a whole other topic for discussion, but technically, you don’t need both people on a loan, and most states will let you do that without factoring in the other spouse.

So that means you could have a high DTI on paper, even though in reality it’s a lot lower.

That’s why it’s important to work with someone like myself and others to help understand where a safe DTI really is – including all income and debts in the household, not just what’s on the loan application.

I’d recommend keeping that DTI at 35% or under, if possible.

I hope that helps demystify what DTI is and what we see as good debt-to-income ratios.

Any questions? Reach out to me, Evan Kaufman, your VA loan originator. Take care!