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. Under federal “qualified mortgage” standards, your back-end ratio maximum was capped at 43%, although with recent announcements from Government Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac, there is wiggle room case by case
Why are the 36%/43%/50% Debt-To-Income Ratio 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 36% of the borrower’s stable monthly income. The maximum can be exceeded up to 45% if the borrower meets the credit score and reserve requirements 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 50%.
The federal “qualified mortgage” rule sets the safe maximum at 43%, although Fannie Mae, Freddie Mac and the Federal Housing Administration (FHA) all have exemptions allowing them to buy or insure loans with higher ratios.
FHA traditionally allowed DTIs over 50% for some borrowers, however those borrowers have to pay private mortgage insurance (PMI), often for the life of the loan.
Freddie Mac also uses private mortgage insurance and will accept loan applications with DTIs above 45%.
Fannie Mae also uses private mortgage insurance on its low down payment loans, but the premiums are automatically canceled when the principal balance drops to 78% of the original property value.
As an prospective borrower, your application will still have to go through Fannie’s automated underwriting system (Desktop Underwriter), which examines your entire application, including the down payment, your income, credit scores, loan-to-value ratio and a slew of other indexes.
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 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.
In general, the front-end and back-end DTI ratios should be 28% and 36% respectively, or lower.
FHA limits are currently 31/43, though these can be higher with justification from the lender.
VA limits (for veterans) are only calculated with a DTI of 41.
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.