Debt-to-income ratio

A debt-to-income ratio (often abbreviated DTI) is the percentage of a consumer's monthly gross income that goes toward paying debts. (Speaking precisely, DTIs often cover more than just debts; they can include certain taxes, fees, and insurance premiums as well. Nevertheless, the term is a set phrase that serves as a convenient, well-understood shorthand.) There are two main kinds of DTI, as discussed below.

Two main kinds of DTI

The two main kinds of DTI are expressed as a pair using the notation x/y (for example, 28/36).

1. The first DTI, known as the front-end ratio, indicates the percentage of income that goes toward housing costs, which for renters is the rent amount and for homeowners is PITI (mortgage principal and interest, mortgage insurance premium [when applicable], hazard insurance premium, property taxes, and homeowners' association dues [when applicable]).
2. The second DTI, known as the back-end ratio, indicates the percentage of income that goes toward paying all recurring debt payments, including those covered by the first DTI, and other debts such as credit card payments, car loan payments, student loan payments, child support payments, alimony payments, and legal judgments.^[1]

Example

In order to qualify for a mortgage for which the lender requires a debt-to-income ratio of 28/36:

• Yearly Gross Income = $45,000 / Divided by 12 = $3,750 per month income.
  • $3,750 Monthly Income x .28 = $1,050 allowed for housing expense.
  • $3,750 Monthly Income x .36 = $1,350 allowed for housing expense plus recurring debt.

What DTI limits are used in qualifying borrowers?

United States

Current limits

Conforming loans

In the U.S., for conforming loans, the following limits are currently typical:

• Conventional financing limits are typically 28/36.
• FHA limits are typically 31/43.^[2]
• VA limits are only calculated with one DTI of 41. (This is effectively equal to 41/41, although VA does not use that notation.)
• USDA 29/41

Nonconforming loans

Back ratio limits up to 55 have become common in recent years for nonconforming loans. The recent spate of defaults by subprime borrowers may produce a market correction that revises these limits downward again. However, how large the adjustment remains to be seen.

Historical limits

The business of lending and borrowing money has evolved qualitatively in the post-World-War-II era. It was not until that era that the FHA and the VA (through the G.I. Bill) led the creation of a mass market in 30-year, fixed-rate, amortized mortgages. It was not until the 1970s that the average working person carried credit card balances (more information at Credit card#History). Thus the typical DTI limit in use in the 1970s was PITI<25%, with no codified limit for the second DTI ratio (the one including credit cards). In other words, in today's notation, it could be expressed as 25/25, or perhaps more accurately, 25/NA, with the NA limit left to the discretion of lenders on a case-by-case basis. In the following decades these limits gradually climbed higher, and the second limit was codified (coinciding with the evolution of modern credit scoring), as lenders determined empirically how much risk was profitable. This empirical process continues today.

Canada

The Vanier Institute of the Family measures debt to income as net income to total family debt. This is a different ratio, because it compares a cashflow number (yearly after-tax income) to a static number (accumulated debt) - rather than to the debt payment as above. The Institute reported on February 17th, 2010 that the average Canadian Family owes $100,000, therefore having a debt to net income after taxes of 150% ^[3]

References

1. ^ "Analyzing Your Debt to Income Ratio". Home Buying / Selling. About.com. http://homebuying.about.com/cs/mortgagearticles/a/debt_to_income.htm. 
2. ^ David Sirota, PhD (2006). Real Estate Finance (11th edition ed.). Dearborn Press. 
3. ^ Roger Sauvé. "A Six Figure Family Day". The Current State of Canadian Family Finances 2010 Report. Vanier Institute of the Family. http://www.vifamily.ca/node/796.