FAQ – Debt To Income
It is important to understand Debt To Income (DTI for several Reasons. Each loan program has different criteria, and the lending companies place their own “Overlays” on the loans making each of the loan companies criteria different as well. This page is an example of how DTI works. With some homework on your part may find that some programs, or a different lender will have criteria that work in your best interest. Remember that this transaction is about maximizing the potential of the transaction for your success not the agent or lenders. Be smart and ask questions. Below is an example which use criteria that is common but which may or may not work with your lender or program. It is used simply to help you understand how DTI works. If you are a Fist Time Home Buyer getting Down Payment Assistance, after reading this section there is a special section that adds more information as it pertains specifically to the programs. Make sure to read the whole page.
How DTI works.
- A buyer never qualifies for a specific purchase price, he qualifies for a maximum payment based upon his income.
- 4,000 in monthly income = 100% of your income
- 2,000 in total monthly credit related debt (including newly proposed house payment) = 50% Debt to Income (2,000 is half of 4,000 = 50%). Now that we have a basic understanding, lets take it a step farther.
In this example the lender says you can have on an FHA loan with
- A Maximum Front End DTI of .38. Thus the maximum that the newly proposed mortgage payment can be is 1,520 per month (4,000 income x .38 = 1,520)
- A Maximum Back End DTI of .50%. Thus the maximum that all credit related debt can be is 2,000 per month.
- These ratios are called 38/50
If we subtract the 38% Front End from the 50% Back End we see that the buyer can have about 12% of debt before it affects how much he qualifies for (50-38=12). Let’s call this the “Allowable DTI Spread”. In our example the buyer made 4,000. Thus 4,000 x .12 = 480. This means that the Allowable DTI Spread in this example of 12% meant that the borrower was allowed his full Front End payment plus and additional 480 of additional debt without affecting the amount he qualified for. Lets check and see if we are correct.
- Back End DTI allows for a maximum 2,000 per month payment
- Front End DTI allows for a maximum 1,520 per month payment
- Allowable DTI Spread is 480
- Buyer wants to make an offer on a home that will result in a Front End payment of 1520 and he has 480 of additional debt thus his Back End DTI is 2,000.
- Buyer wants to make an offer on a home that will result in a Front End payment of 1,600 and he has 100 of additional debt thus his Back End DTI is 1,700
- Declined
- His Front End Payment was only allowed to be 1,520 but the offer he made resulted in a loan with a payment of 1,600. This is not acceptable even it will leave home with a Max Back End Payment lower than allowed.
- His Back end Payments were only 100 dollars (380 less than allowed) but this does not increase the maximum allowable Front End Payment.
- Buyer wants to make an offer on a home that will result in a Front End payment of 1,300 and he has 700 of additional debt thus his Back End DTI is 2,000
- Approved.
- His Front End Payment was allowed to be 1,520 but only if his back end did not go above 2,000. If we take the max allowable Back End DTI of 2,000 and subtract 700 from it we see that he is allowed an adjusted Front End Payment of 1,300 (1,300 payment plus 700 debt = 2,000).
- His Back End Payments were 700 dollars (more than he should have had for his income) so to keep his over all payments below the maximum Back End amount of 2,000 which was allowed, they reduce the amount the would allow his Front End payment to be (down to 1,300).
- Buyer wants to make an offer on a home that will result in a Front End payment of 1,400 and he has 700 of additional debt thus his Back End DTI is 2,100
- Declined.
- His Front End Payment was allowed to be 1,520 but only if his back end did not go above 2,000. If we take the max allowable Back End DTI of 2,000 and subtract 700 from it we see that he is allowed an adjusted Front End Payment of 1,300 (1,300 payment plus 700 debt = 2,000). But he made an offer that would result in a payment of 1,400.
- His Back End Payments were 700 dollars (more than he should have had for his income) so to keep his over all payments below the maximum Back End amount of 2,000 which was allowed, they reduce the amount the would allow his Front End payment to be (down to 1,300).
In conclusion of this section
- A certain amount of debt is expected and allowed, this is what we are calling the Allowable DTI Spread.
- In the cases were a buyers debt exceeds the Allowable DTI Spread, his Allowable Front End Payment is adjusted downward dollar for dollar corresponding with the amount he was over the spread.
- As the buyers allowable Front End Payment is reduced, this results in him qualifying for a smaller purchase price.
- A buyer can never exceed their maximum Front End DTI payment even if their not using their full Back End DTI allowance.
For those of you who are getting First Down Payment Assistance, there is another possibility that is unique to these programs. Minimum Front End DTI. By now you should know that Front End means (House Payment), thus Minimum Front End DTI would indicate that you might be forced to have a payment no less than “X”
Minimum Front End DTI is only seen in some Down Payment Assistance program and it is important to understand it to avoid losing the transaction. Also, most Down Payment Assistance programs require the BEDTI be lowered to 45%. Thus we will adjust the above examples to lower the BEDTI to 45. We will add the new requirement of a Min FEDTI of 30%. This is what we start with.
- 4,000 income
- .38 Max FEDTI = allowable Front End (housing payment ) of 1,520 per month
- .45 Max BEDTI = allowable Back End (total payments) of 1,800 per month
- .30 Min FEDTI = (minimum that your monthly payment must be) of 900 per month
In our last example the buyer had 700 a month is non-housing debt. We see that his back end DTI is 1,800. So 1,800 minus 700 in debt is 1,100 maximum mortgage payments (Front End DTI). But we also have a minimum payment if t00. Thus the buyer must find a house that will provide him with a payment of between 900 and 1,100. monthly payment. This is getting hard now. If the house is to much we will exceed the Max BEDTI. If the house is to cheap we will fail to meet the min FEDTI
In the above example if the buyer had 950 in monthly debt then he would not qualify for the Down Payment Assistance Program because they required a minimum payment that was higher than the maximum allowable payment (they had too much debt). Not all Down Payment Assistance programs have a Minimum FEDTI, but if they do, we must be sure to take it into account or the transaction will fail.
Want even more information? Watch the First Time Home Buyer Tutorial located in our Video Tutorial Section
Still Have Questions? Call 877-696-7373 x777 or email Don Gardnier at Don@sd4u.com
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