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Debt-to-Income Ratio Dana Bain

July 21st, 2015 2:07 PM by Dana Bain

Debt-to-Income Ratio


iStock_000000891462Small“DTI” …a seemingly simple three-letter acronym, but it downright mystifies some homebuyers. Many are not sure what DTI is, how it’s calculated and what role it plays in their home financing but make no mistake, DTI, the debt-to-income ratio, plays a central role in mortgage lending.

In the most basic of terms, DTI compares the amount of debt a borrower has against that borrower’s total income, and it describes how capable a borrower is to pay their monthly mortgage payment.

Many of your clients will understand that basic concept, but you can assist them considerably by helping them grasp the more nuanced aspects of DTI.

Let’s start with how lenders calculate DTI. When lenders compare income to debt, they are comparing all of a borrower’s income to all of that borrower’s debt.

  • Income – the lender totals up not just pre-tax income from a borrower’s job, but income sources such as bonuses, income for contracting, pensions, social security, alimony, dividends, or child support. The lender accounts for everything a borrower earns on a regular or semi-regular basis, but it also places requirements on certain types of income to ensure that income is truly regular and dependable. This gives the lender the gross income.
  • Debt – the lender adds together all of a borrower’s obligations. This includes what would be the total monthly mortgage payment, as well as existing payments on credit cards, student or car loans, other debts requiring regular payments, alimony or child support payments and housing costs, such as rent or mortgage payments, associated with another property.

So, the basic DTI calculation divides the gross income by the total debts. But it’s not exactly that simple. Lenders express the DTI ratio in two figures: the front-end ratio and the back-end ratio.

  • The front-end ratio – compares only housing related costs, such as the mortgage’s principle and interest payments, mortgage insurance, home insurance, property taxes, and association due or Mello-Roos, to the borrower’s income.
  • The back-end debt – ratio compares all of the borrower’s recurring debts plus housing costs (a larger figure) against their income.

DTI Example

Now, how does this factor into qualification? Every lender caps DTI for its loans at different maximum percentiles. Generally, a lender won’t go higher than 43% for back-end DTI for a conventional, conforming loan.  (There are exceptions in special circumstances).

Dana Bain   978-422-2311

 

Posted in:General and tagged: dana bain
Posted by Dana Bain on July 21st, 2015 2:07 PM

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