Qualifying Ratios: What They Are and How They Work
Qualifying ratios are financial metrics lenders use to evaluate a borrower’s ability to repay a loan by comparing debt obligations to income. These ratios help determine whether an applicant will be approved and, if approved, the terms and how much they can borrow.
Key ratios
- Debt-to-Income (DTI) ratio (back-end ratio): Total recurring debt payments ÷ gross income.
- Housing expense ratio (front-end ratio): Housing-related payments ÷ gross income.
How lenders use them
- Underwriting typically combines qualifying ratios with credit scores to decide approval and pricing.
- Online lenders and credit-card issuers often use automated underwriting algorithms, allowing rapid decisions.
- Different loan types emphasize different ratios: personal loans and credit cards focus on DTI; mortgages use both front-end and back-end ratios.
How to calculate
- DTI (monthly): (Total monthly debt payments ÷ Gross monthly income) × 100
- Example: $1,200 monthly debts ÷ $5,000 gross monthly income = 0.24 → 24% DTI.
- Housing expense ratio (monthly): (Monthly housing costs ÷ Gross monthly income) × 100
- Housing costs may include principal and interest, property taxes, homeowners insurance, mortgage insurance, HOA fees, and sometimes utilities.
Ratios can be calculated on a monthly or annual basis; lenders typically use monthly figures.
Typical thresholds and variations
- Common guideline: DTI ≤ 36%, housing ratio ≤ 28%.
- Some lenders allow higher limits:
- Subprime/alternative lenders: DTI up to ~43%.
- Fannie Mae-backed loans: DTI up to ~45%.
- FHA loans: DTI up to ~50% in some cases.
- Lenders consider compensating factors (strong credit score, low loan-to-value, significant reserves) and regional norms (higher housing ratios in expensive markets).
What counts as debt or housing expense
- Debts: minimum credit card payments, auto loans, student loans, personal loans, and other recurring installment obligations.
- Housing expenses: mortgage principal & interest, property taxes, homeowners/hazard insurance, mortgage insurance, HOA fees; some lenders may include utilities.
Tips to improve qualifying ratios
- Pay down or consolidate high-interest balances to reduce monthly obligations.
- Increase gross income where possible (raise salary, add a co-borrower, or document additional income).
- Refinance existing loans to lower monthly payments.
- Save for a larger down payment to lower the mortgage amount and improve loan-to-value.
- Shop multiple lenders for different underwriting guidelines.
Takeaways
- Qualifying ratios measure debt relative to income and are central to loan underwriting.
- Aim for a DTI around 36% or less and a housing ratio around 28% or less, but lender standards vary.
- Improving income, reducing debt, and presenting compensating factors can increase approval chances and better loan terms.