3 min readLab results are a good measure of internal health. A personal trainer offers advice on muscular health. And a therapist can diagnose mental health. But what's a good measure of financial well-being?
As a rule, mortgage lenders prefer a back-end ratio of 28% or lower. And 36% or less is an ideal front-end ratio.Let's unpack what these numbers mean.
What is a debt-to-income (DTI) ratio?
In the lending industry, the debt-to-income (DTI) ratio is one of the key indicators used to gauge financial health.For banks and lenders, your DTI ratio is a snapshot of your financial situation. It gives them an idea of how well you manage your finances and how much of a monthly mortgage payment you can afford. A DTI calculation compares total monthly debt payments to monthly gross income.
Calculating your DTI ratio
When determining a home loan mortgage rate, most mortgage lenders require two separate DTI calculations: the front-end ratio and the back-end ratio.
Front-end DTI ratio
The front-end ratio is the percentage of your gross monthly income that will be used to pay housing expenses. You’ll also hear it referred to as the housing expense ratio.There are typically four housing costs used to calculate front-end debt:
Monthly mortgage payment
Property taxes
Homeowners insurance
HOA dues
Back-end DTI ratio
Back-end debt includes two separate totals. The first is the total of all monthly payments in the categories that appear on a credit report:
Mortgage payment or rent payment
Auto loan payment
Personal loan payments
Student loan payments
Alimony and child support payments
Credit card debt in the form of minimum credit card payments
Monthly minimum payment on a home equity line of credit (HELOC)
Other monthly debt payments included on your credit report
To complete the back-end ratio calculation, add your total monthly payments from the list above to your total front-end debt. This figure, represented as a percentage, is your overall DTI ratio. A high DTI ratio informs lenders that too much of your income goes toward your total monthly debt and that it may be risky to offer you a new loan.Which brings us to the big question: What is a good debt to income ratio?
The ideal debt-to-income ratio
As mentioned above, mortgage lenders like a back-end ratio of 28% or lower. And 36% or less is an ideal front-end ratio.Depending on the type of qualified mortgage you apply for, these ranges may change. For example, Fannie Mae- or Freddie Mac-backed conventional loans may allow for a higher DTI ratio—up to 50%, in some cases. The borrower must have excellent credit, sizable assets, and a substantial down payment.With Federal Housing Administration (FHA) loans, home buyers with a higher DTI ratio often qualify for more competitive interest rates if their credit score is 620 or better. VA loans are even more generous. The maximum allowable back-end ratio increases to 41%, and front-end ratio calculations are not required.If you're confident that your DTI ratio meets the parameters for a qualified mortgage, the next step is to determine your down payment.
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Unison
We're the pioneers of equity sharing, offering innovative ways for you to gain access to the equity in your home. For more than a decade, we have helped over 12,000 homeowners to pursue their financial goals, from home renovations to debt consolidation, retirement savings, and more.
