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Explaining debt-to-income “DTI” and its importance

When mortgage lenders approve borrowers for a loan, that decision is typically based on a standard set of guidelines that are generally determined by the type of loan program. Let's focus on one of the main components of a mortgage approval: Debt-to-Income (DTI) ratio.

Many potential home buyers have only a rough idea before applying — even for a pre-approval letter — about their own DTIs, how lenders view them, and what sort of obstacles they're likely to encounter.

How do I calculate DTI?

Your debt-to-income ratio is all your monthly debt payments divided by your gross monthly income.  This number (reflected as a %) is one way lenders measure your ability to manage the payments you make every month to repay the money you have borrowed.

The lower the DTI ratio a borrower has (more income in relation to monthly credit payments), the more confident the lender is about getting paid on time in the future based on the loan terms.

Your gross monthly income is generally the amount of money you have earned before your taxes and other deductions are taken out.

The lower the DTI ratio a borrower has (more income in relation to monthly credit payments), the more confident the lender is about getting paid on time in the future based on the loan terms. Click To Tweet

What is front-end vs. back-end DTI?

Debt ratios for home loans have two components.

The front-end DTI ratio measures your gross income from all sources before taxes against your proposed monthly housing expenses, including the principal, interest, taxes and insurance that you'd be paying if the lender approved the mortgage you're seeking.

The back-end DTI ratio measures your income against all your recurring monthly debts. These include housing expenses, credit cards, student loans, personal loan payments and others.

Why are the debt-to-income ratios so important?

For loans to be eligible for sale to Fannie Mae or Freddie Mac, lenders have to follow the guideline set by the GSEs.

For manually underwritten loans, Fannie Mae’s maximum total DTI ratio is dependent on the mortgage application credit score and reserve requirements as reflected in the Fannie Mae Eligibility Matrix.

Note that however, for loan case files underwritten through Fannie Mae's Desktop Underwriter automated underwriting system, the maximum allowable DTI ratio is higher.

As an prospective borrower, your application will typically go through the Fannie’s automated underwriting system (Desktop Underwriter), which examines your entire application, including the down payment, your income, credit scores, loan-to-value ratio, etc.

Loan case files underwritten through the Fannie Mae's Desktop Underwriter automated underwriting system, the maximum allowable DTI ratio is higher. Click To Tweet

Takeaways

Studies by the Federal Reserve and FICO, the credit scoring company, have documented that high DTIs doom more mortgage applications — and are viewed more critically by the lenders — than any other factor. And for good reason: If you are loaded down with monthly debts, you’re at a higher statistical risk of falling behind on your mortgage payments.

Conforming loans have to conform with the aforementioned DTI limits.

However, a non-conforming (Jumbo) loan does not conform to purchasing guidelines set by Fannie Mae and Freddie Mac.

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