Basic Terminology: Debt To Income (DTI)

I previously mentioned the LTV ratio as one way lenders judge risk when underwriting a mortgage loan. Another number that is often used is the Debt To Income ratio or DTI. The DTI is the percentage of a borrower's monthly income that goes toward paying their debt. The more debt a borrower has the more likely that they will have trouble paying their mortgage and eventually default on the loan. There are two types of debt ratios that mortgage lenders generally use: front-end and back-end. The front-end ratio looks only at the payments on the new mortgage, while the back-end ratio looks at all of the borrower's debt. Debts such as personal and auto loans, credit cards, alimony and child support, and other mortgages are considered in the back-end ratio. Bills such as utilities and gym memberships are not generally considered. The rule of thumb is that if a debt has an interest rate associated with it then it is considered in the debt ratio. The debt's minimum payment is used to determine the monthly amount. The front-end ratio is also known as the housing ratio, while the back-end ratio is typically just referred to as DTI. Example: You have found a new mortgage loan that looks attractive and that has a payment of $1000 per month. In addition you have a minimum monthly credit card bill of $150 and a $300 car payment. If your salary is $4000 per month then your front-end ratio would be $1000/$4000 = 25% and your back-end ratio would be $1450/$4000 = 36.25%. Different lenders have different guidelines about how high these two ratios can be. Most lenders typically allow a DTI of 36% for conforming loans and up to 50% for non-conforming loans. The Federal Housing Administration (FHA) has guidelines of 29% for the front-ratio and 41% for the back ratio. If your new loan would cause you to exceed the lender's limits then they won't approve the loan. Debt consolidation, or using part of your mortgage proceeds to pay off your other debts, can often result in a lower DTI and allow you to qualify for the loan.