What is Front-End Debt-to-Income Ratio (DTI)
Front-end debt-to-income ratio (DTI) is a variation of the debt-to-income ratio (DTI) that calculates how much of a person's gross income is going toward housing costs. If a homeowner has a mortgage, the front-end DTI ratio is usually calculated as housing expenses (such as mortgage payments, mortgage insurance, etc.) divided by gross income. In contrast, a back-end DTI calculates the percentage of gross income going toward other types of debt like credit cards or car loans.
BREAKING DOWN Front-End Debt-to-Income Ratio (DTI)
To qualify for a mortgage, the borrower often has to have a front-end debt-to-income ratio of less than an indicated level.Paying bills on time, having stable income and a good credit score won't necessarily qualify you for mortgage loan. In the mortgage lending world, your distance from the edge of financial ruin is measured by your debt-to-income ratio, which, simply put, is a comparison of your housing expenses and your monthly debt obligations versus how much you earn.
Higher ratios tend to increase the likelihood of default on the mortgage. For example, in 2009 many homeowners had front-end DTIs that were significantly higher than average, and consequently, mortgage defaults began to rise. In 2009 the government introduced loan modification programs in an attempt to get front-end DTIs below 31 percent.
Lenders usually prefer a front-end DTI of no more than 28 percent. In reality, depending on credit score, savings and down payment, lenders may accept higher ratios, although it depends on the type of mortgage loan. However, back-end debt-to-income ratio is actually considered more important by many financial professionals for mortgage loan applications.
In preparation for applying for a mortgage, the most obvious of strategies for lowering front-end debt-to-income ratio is to pay off debt. However, most people don’t have the money to do so when they are in the process of getting a mortgage – most of their savings is going toward the down payment and closing costs. If you think you can afford the mortgage you plan to get, but your DTI is over the limit, a co-signer might help.
Calculating Front-End Debt-to-Income Ratio (DTI)
To calculate the front-end debt-to-income ratio, add up your expected housing expenses and divide it by how much you earn each month before taxes (your gross monthly income). Multiply the result by 100 and that is your front-end DTI ratio. For instance, if all your housing-related expenses total $1,000 and your monthly income is $3,000, your DTI is 33 percent.