Debt-to-Income Ratios

Mortgage lenders have established standard measures to determine the maximum size mortgage each potential borrower can afford, given their financial circumstance. The intent of these measures is to extend loans that result in a “win” for both the homeowner and the lender.

One such standard is the debt-to-equity ratio. This ratio is simply a calculation of the percentage of gross monthly income that it will take to pay monthly debt if the loan is approved. The debt-to-equity ratio is really comprised of two calculations, referred to as the “front” and “back.” It is written as a ratio, with the standard being 33/38.

The “front” ratio is derived by totaling PITI (principal, interest, taxes, insurance), mortgage insurance, where required, and homeowners association fees, where applicable. This total is then divided by gross income to come up with a percentage. The “back” ratio is derived by adding all of the same expenses, in addition to monthly consumer debt such as credit card payments, installment loans, and car payments.

This total is also divided by gross income in order to arrive at a percentage. In short, housing costs should not exceed thirty-three percent of monthly income. Combined housing and consumer debt should not exceed thirty-eight percent of income.
It should be noted that, although these ratios are standard in the industry, they are guidelines. Lenders can be flexible with these ratios depending on the credit history and the facts of the situation. For example, if the borrower makes a large down payment or has A+ credit, the standard may be relaxed. On the other hand, if the borrower is making a smaller down payment and/or has a marginal credit history, the guidelines may even be applied more stringently.