Just like the Julian and Gregorian calendars separate time between B.C. and A.D., the passage of the Dodd-Frank Wall Street Financial Reform Act separates the way mortgages have been qualified. Loosely, before Christ (and in my opinion, Barney and Chris did hold themselves in quite high regard) many claimed you just needed to “fog a mirror” to get a home loan. But in the crusades that followed the birth of the new law, most residential mortgages must follow the provisions of ability-to-repay or “ATR.” In other words, before Dodd-Frank, lenders had much greater leeway to approve or deny a loan based on any number of factors (or no factors at all), but after Dodd-Frank, the debt-to-income ratio, otherwise known as “DTI” became a critical component of determining ability to repay. We’re going to look at how lenders determine DTI in most cases, but I’m also going to caution about attempting to “do it yourself” (DIY). There’s a lot that goes into DTI and even under much stricter regulation, our industry has various interpretations of the same rules.
What is DTI?
Your debt-to-income ratio, or “DTI” is determined by taking your total monthly obligations and dividing your gross monthly income into them. This will produce a ratio. So, for example, let’s say a homeowner’s total monthly housing payment, plus car payment, plus minimum credit card payments reflecting on the credit report total $4300. Let’s say this borrower earns $10,000 per month in gross income. Our prospect has a DTI of 43% ($4300 / $10,000 = .43). To be more precise, there are actually two ratios in the DTI; the “front-end” or “housing” ratio, and the “back end” or “total” DTI. In our example above, let’s say the borrower’s total monthly housing payment is $3000 (including principal, interest, taxes and insurance). His total debts remain $4300 per month. We’d say this applicant has ratios of 30 over 43, or 30/43. Housing/total or front/back. This matters for some loan programs, such as FHA, which specify that the front-end ratio cannot exceed a certain number (46.99%, with most of our investors) and the back-end likewise (56.99%, again for FHA).
What Goes into DTI?
This is the part that’s much more tricky and this is where I advise my clients not to take matters into their own hands and attempt to qualify themselves at home. “Do it yourself,” or DIY projects might be effective for hanging blinds or tiling a small guest bathroom, but when your mortgage is on the line, it’s quite a different story. So just know that behind the scenes, lenders are tasked with specific requirements for calculating both the income AND the obligations. And the metrics for the calculations themselves may vary with the loan type and the investor whose guidelines are being followed. A great example of just how complex a DTI calculation can be is the classic American Express “open” charge card. These credit cards require the borrower to pay the full balance of the card each month. When we pull a credit report, we’ll see the balance of the card listed as the monthly payment for the card. Now using our example above, what if our same borrower happened to have a $4000 balance on his AMEX? Would we say his DTI is 83%? No, we would not, but we also would not expect the person at home to know exactly why.
Obtaining a better understanding your debt-to-income ratio is a great idea. Attempting to figure it out without the guidance of a mortgage professional is not. I’m happy to invest the time to explain your DTI situation in detail and if you have questions, so let’s get something on the (Julian or Gregorian) calendar.
Measure twice, cut once,
Vice President of Mortgage Lending
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