What is a Debt-To-Income Ratio and Why Does it Matter?

A question I get asked often is “What is the debt-to-income ratio? Debt- to-Income Ratios or DTI for short, are a way we measure a person’s ability to pay their monthly mortgage payment as well their monthly recurring debts. The DTI ratio is one of the most important factors when determining if you qualify for the various loan programs. Simply put, DTI ratios are all of your monthly debt divided by your gross monthly income (GMI). The lower our DTI ratios are, the more likely we’ll qualify for the loan. Let’s take a closer look at how we determine our DTI ratio and why it is so important.

Front/Housing Ratio

There are 2 different DTI income calculations that lenders look for. The first is the front end or housing ratio and the second is the back end ratio. The front ratio is your total housing payment divided by your gross monthly income.  For this example let’s say our borrower makes $50,000 dollars a year. To calculate our gross monthly income   we take our yearly salary and divide it by 12.

GMI: $50,000/12 = $4,166.66 GMI

We’ll say our housing payment is $1,000. The housing payment is made up of a couple different figures. They consist of Principle and Interest, Property Taxes, Homeowners Insurance. A common acronym for the housing payment is PITI.

P– Principal

I-Interest

T-Taxes

I-Insurance

So if our housing payment is $1,000 and our GMI income is $4166.66 then that makes our housing ratios 24%.

Back End Ratio

To calculate the back end ratio we take the housing payments plus all monthly liabilities that show up on the credit report. This may consist of car payment of $250, student loans of $125, and a minimum credit card payments of $50.  We take the housing payment of $1000 plus the monthly debt of $425 and divide that by our GMI to get a back end ratio of 34.2%

Back End Ratio Example:

The higher our income and the less debt we have means a LOWER DTI ratio.

Overview

The reason DTI ratios are so important is because evidence shows that the higher DTI ratios are, the more likelihood of the borrower defaulting on their mortgage. USDA loans have some of the more strict debt to income ratios. Typically they don’t like to see the ratios higher than a 32/43. Conventional and FHA loans are a little more lenient on the DTI ratios and will allow the back end ratio to be as high as 49.99%!

Debt to Income ratios are a great measure of your financial security. The lower your scores the more likely you will be able to qualify for a mortgage. If you have any questions about DTI or if high DTI ratios have prevented you from qualifying in the past please reach out to me and give me a call at 443-786-9887!