When lenders evaluate your mortgage loan application, one of the most important numbers they will look at is your Debt-to-Income (DTI) ratio.
It is a strong indicator of your ability to repay mortgage debt, and therefore how much risk you pose to the lender.
DTI allows a lender to look at a basic risk factor – do you tend to spend a lot compared to what you make? You can have a large income, but if your spending is also disproportionately large, it only takes a minor disruption to send you into a debt spiral.
There are two variations known as the front-end and back-end DTI.
A front-end DTI only considers all housing-related debt, including the mortgage payments, taxes, insurance, and homeowner’s association fees.
A back-end DTI also includes all of your non-housing-related regular debts and monthly expenses, such as car payments, credit card debts, child support, and student loan payments.
Lenders often consider both when reviewing your application, but the back-end DTI is usually given more attention since it is more comprehensive.
Historically, conventional loans have required a DTI of no more than 28 percent front-end and 36 percent back end, although this limit has been stretched at times. VA and FHA loans that have lower risk because of partial government backing can withstand higher DTI ratios, generally in the low-to-mid 40 percent range.
The DTI value was stretched often in the days leading up to the subprime mortgage crisis; since then, lenders, with the encouragement of regulators, have drawn back to the traditional marks.
The current rules from the Consumer Financial Protection Bureau (CFPB) put a DTI limit of 43 percent to be a qualified loan under the new rules, giving lenders incentive to stay under that mark.