Debt to Income Ratios (aka DTI)

This is a follow up to the email I received asking several excellent questions.  I addressed what is required for a full doc loan in my previous post.   Now it’s time to answer Question #2:

1. What type and duration of income documentation is needed for a full doc loan in the current lending environment?
2. What is the debt to income ratio that most lenders are using for loans of this size?
3. What is the typical interest rate differential for a loan of this size compared to the jumbo rates that you quote on Rain City Guide?”

Let’s begin by addressing what a debt to income ratio is.  It’s pretty much like it sounds.  It’s factoring in your monthly payments plus the proposed mortgage payment (PITI = principal, interest, taxes and insurance) and home owners dues, if any.   Your monthly gross income that is used for qualifying is divided into the monthly debt which produces your DTI (debt to income ratio).

Borrowers have a front DTI and a back DTI.  It may look something like 28/38.  The front ratio is the proposed PITI (total monthly payment) divided by your gross monthly income.  The back DTI is really the most important and is essentially the bottom line.  It’s factoring in your total monthly debt plus your proposed new PITI (new mortgage payment) divided by your gross monthly income.

For simplicity sake, let’s assume that you have a minimum of two years employment and are paid a salary of $60,000 before the government takes their portion, insurance, 401k, etc.  $60,000 is the figure that we will use for your gross annual income/12 = your gross monthly income.  Your gross monthly income is $5,000.

For our example, let’s say you have the following:

• $300 car payment (those car payments can really impact your home purchasing power)
• $150 in credit cards (minimum monthly payments)
• $50 in student loans
• If you are paying child support and it’s continuing for 3 years; this is factored into your DTI as well.

Note:  Installment debts with a term of less than 10 months remaining may not be calculated in your DTI ratio.

We have a sub-total of $500 for monthly debts (300+150+50).

The debts are 10% of this persons gross monthly income.   If the allowed total DTI (as referred to as the back ratio) is 45%; then the most this borrower could have for a mortgage payment is 35% of their gross monthly payment (45 allowed – 10% of their current obligations = 35%); they would qualify for a PITI of $1750 (remember, this is including principal, interest, taxes, insurance and any home owner association dues).

Different programs will allow for different DTI ratios.   And (at this present time, although this could easily change in our current mortgage climate) automated underwriting (AUS) dictates a majority of what is allowed for a DTI ratio based on the other strengths of the borrower (down payment, credit, assets, employment, etc).  For example, the less money you put down towards the property, the lower your DTI will be.

Here are some basic DTI ratio guidelines:

• VA Loans:  41%
• FHA Loans: 43-45%
• Conforming 45% plus (depending on the AUS response).
• Non-Conforming 45%
• Second Mortgages 45%

More important than what mortgage guidelines will allow you to have is what is comfortable for you and your household.  Just because you qualify for a higher mortgage payment does not mean that you must have it.   Consider paying yourself first with a monthly allotment going towards funding your retirement or child’s 529 for college tuition.  Leave yourself some wiggle room because life happens when you least expect it.