You might hear the term "debt-to-income ratio" when applying for a credit card, loan or mortgage. It is most commonly used in the mortgage industry, as most mortgage loan products have specific maximum debt-to-income ratios that need to be met in order to qualify for the mortgage.
Definition
Debt-to-income ratio, also known as DTI, is calculated by dividing the debt payment by your monthly income. In some cases, this ratio is calculated by adding up several debts and then dividing with your monthly income. The percentage that results is called your debt-to-income ratio, and it is a factor that some lenders use in determining whether you qualify for the credit product that you are applying for.
Mortgages
The first time that many people hear about debt-to-income ratios is in relation to a mortgage. Mortgages use two debt-to-income ratios, called front-end and back-end ratios. The front-end ratio is concerned with only your debt to income when it comes to a mortgage. The prospective mortgage amount and any mortgage insurance and property taxes are added up and divided by your gross monthly income to produce the front-end number. The back-end number adds the total mortgage payment plus your other debt obligations, such as credit cards and car payments, and divides it by your monthly income. Both of these numbers are used in calculating whether you qualify for a mortgage.
Common Ratios
The common ratios used by mortgage companies generally depend on the type of mortgage that you are applying for. A conventional mortgage, which is a standard mortgage product offered by a bank, usually has limits of 28 percent front end and 36 percent back end. Special mortgage products, such as those offered by the Federal Housing Administration, allow for a higher 31 percent front-end and 41 percent back-end ratio. Ratios may be higher on a case-by-case basis if other mitigating factors are present, such as a large amount in savings, high credit score or higher down payment.
Rental Homes
When you rent an apartment, the landlord calculates a debt-to-income ratio to see if you can afford the apartment payments. Generally with rentals, the only debt number used is the actual rent payment, and he does not calculate other types of debt into the number. Landlords are usually looking for a rental payment that does not exceed greater than 30 percent of your monthly income.