Debt To Income Ratio – This ratio (abbreviated DTI ) is the percentage of a consumer’s gross monthly income that goes toward debt service. It’s is one of the main factors that a lender takes into consideration when approving a loan.
There are actually 2 debt ratio categories – front end and back end. The front end ratio is the percentage of gross monthly income (before taxes) that is used to pay your housing costs. Housing costs include: principal, interest, taxes, insurance, mortgage insurance (if applicable), and homeowners association fees (if applicable). The back end ratio is comprised of the same elements, but also includes your monthly consumer debt. Consumer debt includes, car payments, credit card debt, installment loans and similar debt. Auto insurance, cell phone bills, and debts with less than 10 remaining payments are not counted.
A common guideline for DTI ratios is 33/38 (front end/back end). Lenders typically do not want to see your housing expense consume more than 33% of your monthly income. If you add your monthly consumer debt, the back end ratio should not exceed 38%.
There is some flexibility in the guidelines. For example, if your back end ratio is 45%, but if your FICO credit scores and your job stability are excellent, many lenders will make an exception and approve the loan. If you make a larger down payment, the guidelines are less rigid as well.
Guidelines also vary according to loan program. A back end debt ratio on a VA loan can goes as high as 41%. It makes a lot of sense to have a reputable lender analyze your debt to income ratio on a theoretical purchase before you start shopping for a home. From a practical standpoint, it also will help you set up a budget. In the past few years, many loans were issued to people without considering the debt ratios of the borrower. As we know now this was not a good practice!
In next week’s Mortgage Corner, we take a look at down payment options.
Steve Madonna
Weichert Financial Services
610-566-2045
