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Debt-to-Income Ratio: Understanding Frontend and Backend DTI

When you visit a mortgage lender, you may feel that you’re overrun with terminology. At times it seems like the industry is almost intentionally confusing you with an alphabet soup of jargon.

But we believe an informed homebuyer is a better homebuyer; a knowledgable borrower is a more successful borrower. With that in mind, we do our best to provide information on some of the most basic and important, yet sometimes confusing, terms in the real estate industry.

Debt-to-income ratio, known as “DTI,” is one of those terms. As a reflection of your debt load compared to your total income, DTI is part of the broader way in which lenders determine your borrowing capabilities.

Understanding DTI: Frontend vs Backend

Debt-to-income ratio is simply a way of comparing your monthly debt payments to your monthly income, and it’s always expressed as a percentage.

Suppose you have a monthly income of $10,000 and monthly debt payments of $2,500. In this case, your DTI would be 25%, as your debts account for 25% of your income.

To get the percentage, simply take the payments (in this case, $2,500) then divide by the income (in this case, $10,000). This leaves you with .25; now simply move the decimal point two spots (transferring it to a percentage) to get 25%. It really is that simple.

Note: DTI always looks at your pre-tax income, not your take-home pay after taxes. Therefore, you need to understand your total earnings, not just the post-tax amount on your taxes. This does work in the borrower’s favor, as the “income” in DTI is higher: suppose you earn $10,000 a month, but take home $7,500 after takes. With a $2,500 debt load, your DTI is 25%, but if you were to use $7,500 (after taxes), your DTI would be 33%.

But it can be complicated by two types: frontend and backend. But don’t worry, once you understand these two, you are basically all set when it comes to understanding DTI.

What is Frontend DTI?

The frontend is actually the most simple of all DTI calculations. It’s simply a comparison of the expected mortgage and housing expenses (principal, interest, taxes, and insurance) against your income. If you know exactly how much your payment will be, and you know exactly how much you make every month, you can easily calculate your frontend DTI.

What is Backend DTI?

Backend DTI can be a little more difficult, as it takes more research and math to reach the final number. But don’t worry, it’s still very simple.

Backend ratio is simply the relationship between all of your debt obligations compared to your income. It takes a broader look at your expenses and helps lenders better understand your monthly budget, as well as your ability to repay the mortgage.

When considering your backend DTI, pretty much every kind of monthly loan payment or debt bill will be included. Auto loans, personal loans, credit cards, and other forms of debt will be added into the debt load. Garnishments and other court-ordered payments (alimony, child support, etc.) will also be a part of the calculation. Student loan debts are also included, and this can have a strong impact on the backend DTI for many of today’s aspiring homeowners.

Other expensed will not need to be included as long as they are non-recurring or fluctuating. Medical costs, for example, probably won’t be calculated, but medical-bill repayment plans could be part of the backend DTI. Cable, internet, and gas bills are usually not a part of the DTI process. Neither is food, entertainment costs, and other expenses.

Why is DTI so Important to Lenders?

A low ratio can increase your chances of mortgage approval.

Why should it matter if all your other debts are 10%, 25%, or 60% of your income. As long as you can still afford to pay the mortgage, why would lender care? They care because it’s a strong predictor of your likelihood to repay the loan.

People with low DTIs are, statistically, less likely to default on the loan. This makes sense, as someone with a low DTI has more financial flexibility, so large emergency expenses or drops in income won’t hit them as hard; they can still afford the mortgage.

How Does DTI Impact Your Loan

A high DTI can impact your loan in two specific ways. First, you could be outright rejected for a loan. Second, you could have a higher interest rate on the mortgage, which would mean spending more on your monthly loan bill.

It’s also possible that if your DTI is high, lenders may require a larger downpayment, increasing your upfront costs.

What’s a Good DTI?

The specific requirements for DTI will vary, and some loan products have high or low DTI requirements.

Lenders generally like to see a specific range for all borrowers. For a front-end DTI, lenders generally prefer something less than 30%, usually capping their allowable percentage at 28% to 32%. Some government-sponsored programs allow for a debt load that is even higher; FHA loans, for example, may be available with a ratio of 35% as long as the lender does not have their own restrictions.

For backend, you’ll usually need a DTI somewhere around 45% or less to get approved for the mortgage, although there are options that allow for backend DTIs as high as 55%.

It’s best not to get too concerned over your ratio and instead focus your attention on responsible management of debt and your finances. Most people, without even realizing it, have backend DTIs that are well within the range that lenders prefer.

You don’t need an exact number, but it never hurts to sit down and calculate your backend DTI. Think about all of your expenses, tally your monthly income, then calculate your DTI. If it looks like you may have a DTI that is above 50%, you can make changes to reduce your debt burden and increase your chances of loan approval.

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