Definition
A consumer’s debt-to-income ratio is a calculation of their monthly debt payments as a percentage of their gross monthly income. This is also known as a qualifying ratio for mortgage lending purposes.
Analysis
Debt-to-income ratios do not appear on credit reports and are not factored into credit scores. Credit scores ignore income, which is difficult to verify.
A consumer’s debt-to-income ratio is very important however on a credit application. Prospective mortgage applicants find out that there are two important debt-to-income ratio calculations that are important in the loan underwriting process.
An applicant’s front ratio is a measure of their housing costs (rent or PITI) as a percentage of their gross monthly income. An applicant with $1,000 in monthly housing costs and $3,400 in monthly gross income would have a front end debt-to-income ratio of 29%, which barely exceeds the 28% financing limit for conventional mortgage loans. However, they could still qualify for an FHA loan, which allows a front ratio of up to 31%.
An applicant’s back ratio looks beyond housing costs to measure their total monthly debt obligations. This same applicant with $1,000 in monthly housing costs and $3,400 in monthly gross income may have a $300 car payment, $150 in credit card minimum payments and a $100 student loan payment due each month. This would provide a back ratio of 45.6%, which exceeds the conventional mortgage limit of 36% and the FHA limit of 43%. Thus, this applicant would not become eligible for either loan product until they repaid some debt, increased their income or lowered their monthly housing costs.
