Debt-to-Income Ratio
“Debt-to-income ratio”, or “DTI ratio” as it’s known in the industry, is the way a bank or lender determines what you can afford in the way of a mortgage. By dividing all of your monthly liabilities by your gross monthly income, they come up with a percentage. This figure is known as your DTI, and must fall under a certain percent in order to qualify for a mortgage.
The maximum debt-to-income ratio will vary by lender, loan program, and investor, but the number generally ranges between 40-50%.
Let’s look at a basic example:
$120,000 annual gross income as reported on your tax returns/pay stubs
- Monthly liabilities: $3,500
- Monthly income: $10,000
- 35% DTI
In this example, your debt-to-income ratio would be 35%. However, the DTI ratio goes into greater detail and comes up with two separate percentages, one for all of your monthly liabilities versus income (back-end DTI ratio), and one for just your monthly housing payment (including taxes and insurance) versus income (front-end DTI ratio).
Front-End and Back-End Debt-to-Income Ratios
So in the above example, if your monthly housing payment makes up $2,000 of your $3,500 in monthly liabilities, your front-end DTI ratio would be 20%, and your back-end DTI ratio would be 35%. Many banks and lenders require both numbers to fall under a certain percentage, though the back-end DTI ratio is more important.
You may see a debt-to-income requirement of say 30/45. Using the example from above, your front-end DTI ratio of 20% would be 10% below the 30% limit, and your back-end DTI ratio of 35% would also have 10% clearance, allowing you to qualify for the loan program, at least as far as income is concerned.
