Definition of DTI and How Is It Calculated
Definition of DTI ratio and how is it calculated
Understanding the definition of DTI ratio and how is it calculated is essential for borrowers, as it explains how lenders evaluate their ability to manage monthly debt obligations and qualify for a loan.
The Debt-to-Income (DTI) ratio is a key metric used by lenders to assess a borrower’s ability to manage monthly payments. It is calculated to analyze a borrower’s capacity to repay the debt by its final maturity, assuming a fully amortizing repayment schedule.
The DTI ratio provides an overall assessment of credit risk, where generally, the lower the ratio, the lower the risk.
Calculation: Total Monthly Debt Obligations vs. Gross Monthly Income
The DTI ratio compares the borrower’s total monthly debt obligations (including the new proposed housing payment) to their gross (pre-tax) monthly income.
DTI Ratio = Gross Monthly Income/Total Monthly Debt Obligations?
I. Calculation of Total Monthly Obligations (Numerator)
The Total Monthly Obligations must include all recurring long-term debt. Specific debt types requiring inclusion or exclusion are detailed in the guidelines:
- Solar Panel Debt: Monthly obligations for solar panels must be included in the DTI ratio regardless of how they are financed.
If panels are financed and collateralized by another loan, the debt obligation must be included.
If the panels are subject to a lease or Power Purchase Agreement (PPA), the monthly lease or PPA payment must be included. - Installment Loans: Installment loans being paid off that have 10 or fewer remaining monthly payments generally do not need to be included in the long-term debt calculation.
- Secured Loans: Monthly payments for borrowed funds secured by an asset the borrower owns (like a 401(k), stocks, or a car) do not have to be considered as long-term debt during qualification.
- Collections/Charge-offs: Borrowers are not required to pay off outstanding collections or non-mortgage charge-offs for loans secured by a one-unit principal residence, regardless of the amount. (Therefore, the monthly payment for these specific debts is generally not included in the calculation.)
II. Calculation of Gross Monthly Income (Denominator)
The Gross Monthly Income used in the DTI calculation must be stable, predictable, and verifiable.
- Rental Income (General): When using lease agreements or market rents, the qualifying rental income is calculated by multiplying the gross monthly rent(s) by 75%. This reduction accounts for vacancy and maintenance losses.
- Rental Income (Other Properties): Income from rental properties owned by the borrower (not the subject property) must be documented using the borrower’s most recent signed federal income tax return, including Schedule 1 and Schedule E.
- Accessory Dwelling Units (ADU): Rental income from an ADU can be used for qualifying purposes if the property is a one-unit principal residence and the transaction is a purchase or limited cash-out refinance. The qualifying rental income from the ADU cannot exceed 30% of the borrower’s total qualifying income.
- Self-Employed Borrowers: If the borrower has 25% or more ownership in a business, the lender must perform a business cash flow analysis to ensure the income is stable and consistent before it is included in the income calculation.
- Ineligible Income: Any income paid or earned in the form of virtual currency (cryptocurrencies) is not eligible to be used to qualify for the conventional loan.
Maximum DTI Ratios for Conventional Loans
The maximum allowable DTI ratio for a conventional loan depends entirely on the underwriting method used:
| Underwriting Method | Standard Maximum DTI Ratio | Conditions |
| Automated (Desktop Underwriter – DU) | 50% | The DTI ratio is generally higher because DU performs a comprehensive analysis of compensating factors (e.g., credit score, reserves, utilization) simultaneously. |
| Manual Underwriting (Standard) | 36% | This is the general, conservative limit applied when a human underwriter assesses risk without the full automated analysis. |
| Manual Underwriting (Maximum) | 45% | May be achieved if the borrower meets specific credit score and financial reserve requirements as compensating factors. |
| Manual Underwriting (No Credit Score) | 36% | Strictly limited to 36% for borrowers without a traditional credit score, even if compensating factors exist. |
For Jumbo Loans, which are a type of non-conforming conventional loan, the maximum DTI ratio is typically 43% or lower, ideally 36% or less.
FAQ's
For a Jumbo Loan (a non-conforming conventional loan), the DTI ratio is typically stricter than conforming loans, usually required to be 43% or lower, and ideally 36% or less.
The DTI ratio helps the lender analyze the borrower’s capacity to repay the debt by its final maturity, assuming a fully amortizing repayment schedule.
The maximum DTI for manually underwritten loans can be extended to 45% if the borrower meets specific requirements for their credit score and financial reserves.
For manually underwritten loans, the standard maximum DTI ratio is 36%.
DU allows a higher DTI limit because it performs a comprehensive analysis of a vast dataset of compensating factors simultaneously. These strengths, such as significant cash reserves or a high credit score, offset the risk of a higher DTI.
For conventional loans underwritten through the Desktop Underwriter (DU) automated system, the maximum allowable DTI ratio is generally 50%.
The income figure used in the DTI ratio calculation is the borrower’s gross (pre-tax) monthly income.
The debt portion, known as the Total Monthly Debt Obligations, must include the new proposed housing payment (PITIA) plus all other recurring long-term debt liabilities of the borrower.
The DTI ratio is calculated by comparing the borrower’s total monthly debt obligations (which include the new proposed housing payment) to the borrower’s gross (pre-tax) monthly income.
The Debt-to-Income (DTI) ratio is a key metric used by lenders to assess a borrower’s ability to manage monthly payments. It is considered a key risk factor for loans underwritten through the Automated Underwriting System (DU).
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