Mortgage lenders use a set of ratios as one of the measures in qualifying an applicant for a mortgage loan. The two ratios measure the amount of your monthly income that goes toward paying debt. One ratio, the front-end ratio, only considers your potential housing costs if you’re approved for the mortgage. The other ratio, the back-end ratio, looks at how much of your income would be spent on housing costs and other debt if you’re approved for the mortgage. Lenders use these ratios to ensure you’d be able to repay the mortgage loan if you’re approved.
When you see a mortgage advertised, the ratios are listed like this: 29/35. The first number is the maximum front-end ratio and the second number is the back-end ratio. Generally, your ratios need to be at or below these two numbers to qualify for the loan. Keep in mind this was just an example. The actual ratios could be higher or lower depending on the loan, lender, or program.
The front-end debt to income ratio is also known as the housing ratio (DTI). It calculates the percentage of your monthly income that would be spent on the mortgage. The ratio uses your total monthly housing payment, including mortgage, insurance, property taxes, and any HOA fees and divides that amount by your monthly gross income. The maximum front-end ratio for a typical FHA loan is 31%.
If you don’t know your monthly income, you can figure it out based on what you do know. Divide your annual salary by 12 to get your monthly gross income. Or multiply your bi-weekly gross income by 2 to get monthly gross income. If you’re an hourly employee, multiply your hourly wage by 160 (the estimated number of working hours in a month) to get your monthly gross income.
If your monthly gross income is $4,500 and the monthly housing expenses on the mortgage you’re considering equal $1,500, the front in debt-to-income ratio would be 33.3%. The housing expenses would have to be less than $1,395 to qualify for a mortgage with a maximum front-end ratio of 31%.
To come up with the maximum housing payment for a specific ratio, multiply your monthly gross income by that ratio. For example, you would multiply a monthly gross income of $3,700 by .31 to figure out the housing payment for that loan. The answer would be $1,147.
The back-end debt to income ratio measures the percentage of your housing and debt payments. To calculate the ratio, the lender adds up your monthly housing and monthly debt payments, then divides the total by your monthly income. Utilities, cell phone, and other non-debt payments aren’t included in the back-end debt-to-income ratio calculation. The maximum back-end loan for many FHA loans is 43%.
Again, let’s say your monthly gross income is $4,500. And let’s also assume your housing expenses are $1,300 and other monthly debt payments are $600. Your back-end ratio would be 42.2% and just within range to qualify for an FHA loan.
Ratios Used in Loan Approval
These debt-to-income qualifying ratios aren’t the only factors that lenders use to decide whether you qualify for a mortgage. Your credit score, amount of debt, down payment, and job history are just a few other factors that come into play. So, even if you fall well within the ratios, your credit rating, job history, or low down payment could keep you from being approved.
It’s quite possible to be approved for a mortgage even if your numbers exceed the two debt-to-income ratios, especially if you have a high credit score or high down payment to offset the risk associated with a high ratio.
Qualifying ratios also vary from one lender to another and even with different loan programs offered from the same lender. Both market conditions and loan-to-value ratio of the mortgage can also affect the qualifying ratio for a particular mortgage.