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Lab results are a good measure of internal health. A personal trainer offers advice on muscular health. And a therapist can diagnose mental health. But what's a good measure of financial well-being? As a rule, mortgage lenders prefer a back-end ratio of 28% or lower. And 36% or less is an ideal front-end ratio. Let's unpack what these numbers mean.
What is a debt-to-income (DTI) ratio?In the lending industry, the debt-to-income (DTI) ratio is one of the key indicators used to gauge financial health. For banks and lenders, your DTI ratio is a snapshot of your financial situation. It gives them an idea of how well you manage your finances and how much of a monthly mortgage payment you can afford. A DTI calculation compares total monthly debt payments to monthly gross income.
Calculating your DTI ratioWhen determining a home loan mortgage rate, most mortgage lenders required two separate DTI calculations: the front-end ratio and the back-end ratio.
Front-end DTI ratioThe front-end ratio is the percentage of your gross monthly income that will be used to pay housing expenses. You’ll also hear it referred to as the housing expense ratio. There are typically four housing costs used to calculate front-end debt:
- Monthly mortgage payment
- Property taxes
- Homeowners insurance
- HOA dues
Back-end DTI ratioBack-end debt includes two separate totals. The first is the total of all monthly payments in the categories that appear on a credit report:
- Mortgage payment or rent payment
- Auto loan payment
- Personal loan payments
- Student loan payments
- Alimony and child support payments
- Credit card debt in the form of minimum credit card payments
- Monthly minimum payment on a home equity line of credit (HELOC)
- Other monthly debt payments included on your credit report