Debt to Income Ratio

The speaker reviews a common mortgage qualification ratio, the debt to income ratio.  He mentions that debt to income ratios measure your debts in terms of your gross income.  Different loan programs require different DTI ratios to qualify.  Many loan programs follow a 29/41 ratio qualifier.  This means that 29% of your gross income can be used to pay your monthly mortgage payment, while 41% of your gross income can be used for your mortgage and all your other debts.  The 29/41 is the FHA loan recommendation, but other loan types can have different standards.

Your debt to income ratio is simply the percent of your gross income that goes toward paying bills or other debts.  This is one of the most important indicators that banks use to qualify you for loans.  There are two forms of the debt to income ratio that are looked at; they are called the front raio and the back ratio.

The formula for the debt to income ratio is:  Debts / Gross Income

Front Ratio & Back Ratio

The front ratio establishes your ability to pay your basic living expenses such as mortgage principal and interest, insurance, and Taxes (PITI).  Additionally, if you property is part of a homeowners association, association dues will be included in the front ratio.  Based on our formula above, these items will be tallied up and included in the "Debts" portion of the formula.  Gross income can be found on your W2; if you have more than 1, sum up the aggregate amounts to get your total gross income. 

The back ratio is a more realistic measurement of the borrowers ability to make the monthly payments as it includes the items in the front ratio as well as recurring debts to determine the DTI.  Recurring debts could include car loans, student loans, credit card loans, alimony, or any other debt that can be found on your credit report. 

Debt To Income Ratio Requirements

To receive a conventional loan, or a loan that the banks can sell to Freddie Mac & Fannie Mae, it is required that your DTI be no more than 28% for the front ratio and 36% for the back ratio.  If you can get approved for a conventional loan, you will receive the best interest rates on the market.

For FHA loans, the DTI requirements are a bit more relaxed, only requiring 31% on the front and 43% on the back ratio. 

The non-conforming, or sub-prime borrowers historically needed to maintain a DTI of less than 55 for the back ratio.  As we can now see, this ratio allowed for very weak borrowers to assume loans that they could not afford.  To add fuel to the fire, these borrowers were allowed to take hybrid loans which adjusted the rates to levels which broke the proverbial "camel's back".