Debt-to-Income Ratio (DTI) Explained
One of the first things a lender will analyze when you apply for a mortgage is your debts. The lender wants to make sure that you can afford a new mortgage payment each month in addition to any other debts and monthly payments you already have. The total amount of these debts or payment obligations compared with your monthly income creates two different kinds of debt-to-income ratios (or DTI) that the mortgage lender reviews:
Your housing ratio (also called a “front-end ratio”) is discovered by added up your estimated new mortgage payment and the other fees and costs involved in homeownership on a monthly basis. This includes property taxes, mortgage insurance, homeowner’s insurance, and any HOA fees. Some of these are included in your monthly mortgage payment. The lender will then divide your expenses and mortgage payment by your monthly income.
Total Debt Ratio
The second DTI ratio calculated is called a total debt ratio (also called a “back-end ratio”). This involves analyzing debts that appear on the borrower’s credit report like minimum credit card payment requirements, car payments, student loan expenses, etc. This is all added up with your mortgage payment and divided by your monthly income.
Limits on DTI Ratios
Most of the time lenders prefer that the front-end and back-end ratios in the borrower’s financial profile be equal to or less than 28% and 36%, however some lenders can be willing to qualify a higher back-end ratio by approving a non-conforming loan for you. This kind of loan gets its name since it does not conform to Fannie Mae and Freddie Mac’s purchasing guidelines, which are what regulate credit scores, LTV ratios, and DTI ratios. These loans are usually considered much riskier to the lender though, so they cost the borrower more.