Debt to Earnings Ratios, often referred to as “DTI’s”, are a crucial calculation employed in the refinance, debt consolidation, and buy mortgage application practice. A debt to income ratio is achieved by dividing your monthly debt payments by your pre-tax income. Debt to income ratios are ultimately used to decide how much money you can borrow, and a detailed knowledge of DTIs can help you get the most value from your refinance, debt consolidation or purchase mortgage transaction
There are two distinct types of debt to income ratios which are used in refinance, debt consolidation or purchase mortgage underwriting, a Front End Ratio (or “Front Ratio”) and a Back End Ratio (or “Back Ratio”).
The Front Ratio is calculated by dividing the sum of your total monthly housing costs, composed of your mortgage payment including principal interest taxes and insurance as well as homeowner’s association fees, mandatory maintenance fees, common charges in a development and mortgage insurance if applicable.
The Back Ratio is similar to the front ratio, but on top of basic housing expenses the back end ratio also includes your other monthly debt payments, particularly consumer debt payments, into the calculation. Examples of monthly consumer debts are your credit card bills, automobile payments, personal or student loans, etc. Examples of items not typically included in a back end ratio would be life, health & car insurance premiums.
When your lender is evaluating your application, they are in fact trying to match your application with the lending criteria for the program which you want to see if you qualify for the loan. While there are many factors in determining how much money you can borrow and at what rate, debt to income ratio is amongst the most important. A good credit, conventional mortgage program will very often have a debt to income ratio requirement of 33/38 – front/back, meaning that your monthly housing costs should be less than one third of your gross income per month.
If you make $3,000.00 per month, that means the maximum mortgage payment you could qualify for under a 33/38 program would be $1,000.00 per month inclusive of principal interest taxes and insurance as well as other housing costs, and your will only be allowed a total monthly expenditure including mortgage, credit cards and other consumer debts totaling $1,140.00. That may seem very conservative, and it is. If you’ve ever been turned down by a brick and mortar bank for a mortgage refinance, debt consolidation loan or for financing a new home purchase, chances are it had something to do with your program’s low debt to income ratio.
Many modern lenders are not as concerned about the back end ratio at all and decide solely on the basis of the front ratio, and in the case of a veteran’s VA loan, their guidelines only concern the back ratio and ignore the front. FHA loans allow you to carry more consumer debt but with a higher income requirement, with a standard debt to income ratio guidance of 29/41 – front/back.
Progressive lenders now have programs with excellent rates which allow individuals to borrow up to 100% financing and in certain cases up to millions of dollars at even better rates than many of 33/38 programs, but which allow for a debt to income ratio of up to 55% or even 60% in some cases, whether you prove your income through tax returns and W2 forms or simply state how much you earn. These relaxed debt to income ratio criteria allow you to borrow more easily without the fear of rejection, and the better your credit and the larger your down payment in the case of a purchase or equity in the case of a refinance or debt consolidation the more relaxed these criteria can be. Debt consolidation programs can often make it much easier to qualify if you mandate that certain consumer debt accounts be directly paid off, thereby reducing your mo
nthly consumer debt payments. Contact a nationally capable mortgage broker so that you have access to a wide variety of programs, and be honest with your loan officer about your earnings and debts and things will go smoothly. Remember, they want to get you the money you need, and will work with you to make sure that happens.