What are front-end and back-end debt-to-income (DTI) ratios?

A debt-to-income ratio is the percentage of a consumer’s monthly gross income that is spent on repaying debts.

Gross income is the total income earned by a consumer. It is not to be confused with net income which is the amount received on a paycheck after paying government and states taxes.

Calculating a debt-to-income (DTI) ratio is important to determine a realistic budget for a new home purchase and how much a lender will approve for a new mortgage loan. It helps potential homeowners decide on what they can realistically afford to repay over time. Mortgage lenders use DTI ratios alongside credit scores and other factors to determine the likelihood of a borrower repaying their mortgage loan debt.

There are two kinds of DTI ratios: front-end ratios and back-end ratios.

Front-End Ratios

Front-end ratios calculate the amount of gross income that goes towards housing costs. For a homeowner, the front-end ratio can be calculated by adding up all housing expenses such as mortgage payments and insurance, and dividing it by the homeowner’s gross income.

For example, a consumer with a monthly gross income of $4,000, who owes $1,500 in monthly mortgage payments, would have a front-end DTI ratio of 38 percent.

Back-End Ratios

Back-end ratios calculate the amount of gross income that goes towards paying all monthly debt payments, including housing costs, credit card payments, car loans, student loans, and any other debts.

For example, a consumer with a monthly gross income of $10,000, who has $3,500 in monthly liabilities (a $2,000 monthly mortgage payment and $1,500 in credit card and monthly auto loan payments), would have a back-end DTI ratio of 35 percent.

How DTI Ratios Are Used

In order to qualify for a mortgage loan, the borrower must have a front-end DTI ratio that is less than the level set by a certain lending institution. Your DTI ratio is something you should look at if you’re considering buying a home. Higher ratios increase the likelihood that a borrower will default on a home loan. According to Bank of America, most lenders want back-end debt to account for no more than 36 percent of a consumer’s gross income.

Government-backed mortgage loans offer different DTI ratio standards.

For FHA loans, the current qualifying ratios are 31 percent for front-end ratios and 43 percent for back-end ratios. For borrowers under the FHA’s Energy Efficient Homes, the ratios are stretched to 33 percent and 45 percent, respectively.

For VA loans, the maximum back-end ratio to qualify for a new mortgage loan is 41 percent.

If a consumer’s DTI ratio is too high, it is best to lower that ratio before moving forward with a new mortgage loan application. Paying down student debts, personal loans, and credit cards will help to improve a potential borrower’s chances of gaining lender approval.

Another option is to consider a less expensive home. If a $200,000 home will cause a borrower’s DTI ratio to increase past the non-government standard limit of 36 percent, the consumer can consider lowering his or her standards to something more manageable for the long-term.

These stipulations hold true even during difficult economic times like the coronavirus pandemic of 2020-2021. Even though the federal government created a program the Paycheck Protection Program for small businesses to keep them from going bankrupt, female business owners were largely cut out of the first round of funding.

Female business owners who did not receive a Paycheck Protection Program loan might be inclined to seek out a different loan from a national, state, or local bank. Their DTI ratio comes into play in this situation. If their DTI ratio isn’t low enough, they might not be able to receive a loan.

Fortunately, the federal government has rolled out new Paycheck Protection Program rounds for female business owners (and minority business owners as well) to get a loan after male business owners dominated the first round.

Before applying for a loan, make sure it’s the best idea for you. Ask questions like, “how large of a loan can I get based off of my monthly income?” “Will my credit score effect my eligibility to get a loan?” “Can I make monthly payments on a loan?” and “What’s the minimum payment on my loan?”

Remember to save money for your extra payments as well. Such as your rent, student loan payments, and property taxes. You might also have other monthly expenses, such as homeowners insurance and other personal loan payments.

Make sure you work with a mortgage lender that is understanding of you and your needs. Make sure they answer your questions and are will to help.

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