Understanding Debt-To-Income Ratio
When applying for a loan modification, your debt-to-income (DTI) ratio is the key to calculating an affordable house payment. President Obama’s foreclosure prevention plan sets the target front-end DTI for the first mortgage at 31 percent. In other words, your house payment or PITIA (principal, interest, taxes, insurance, and homeowner association fees) cannot exceed 31 percent of your gross monthly income. The DTI ratio comes in two flavors:
- Front-end DTI ratio is based on your house payment. (Under the Obama plan, the front-end DTI target of 31 percent accounts only for the first mortgage. If you other loans against your home, such as a second mortgage or home equity line of credit, you account for those separately as part of your back-end DTI.)
- Back-end DTI ratio is based on all monthly debt payments combined, including your house payment, credit card payments, payments on auto loans, and other loan payments.
Calculating Your Front-End DTI Ratio
To calculate your front-end DTI, divide your house payment by your gross monthly household income:
House Payment / Gross Monthly Household Income = Front-End DTI Ratio
This is easy, assuming your monthly house payment includes a monthly amount held in escrow to pay your property taxes, homeowner’s insurance, and any homeowner association fees. Such a payment is often referred to as PITIA (principal, interest, taxes, insurance, and association fees). You simply divide your PITIA amount by your gross monthly household income.
If you pay property taxes, insurance, and homeowner association fees separately, then add them all up, divide by 12 months, and add the result to your monthly house payment (principal and interest). You can then divide the resulting house payment by your gross monthly household income to determine your front-end DTI ratio.
Note: Private mortgage insurance (PMI) payments fall outside this calculation under President Obama’s guidelines.
Calculating Your Back-End DTI Ratio
To calculate your back-end DTI ratio, add up all your monthly debt payments, including:
- House payment or PITIA, as discussed in the previous section
- Any payments on second mortgages, home-equity loans, or home-equity lines of credit
- Credit card payments
- Auto loan or lease payments
- Other payments on credit accounts or loans
Now, divide your total monthly debt payments by your total gross monthly household income:
Monthly Debt Payments / Gross Monthly Household Income = Back-End DTI Ratio
Exploring DTI Ratios Under Obama’s Foreclosure Prevention Plan
The government’s Home Affordable Modification Program accounts for both front-end and back-end DTI ratios. When attempting to reach the 31% Target Front-End DTI, the focus is only on the first mortgage:
- For qualifying homeowners, the lender will have to first reduce payments on the first mortgage to no greater than a 38 percent front-end DTI ratio. Treasury will match further reductions in monthly payments dollar-for-dollar with the lender/investor, down to a 31 percent front-end DTI ratio.
- Borrowers who qualify for a modification but would have a post-modification back-end DTI ratio greater than or equal to 55 percent, will be provided with a letter stating that they are required to work with a HUD-approved counselor. The modification will not take effect until they provide a signed statement indicating that they will obtain counseling.
Keep in mind that only lenders, investors, and servicers who choose to participate in this program are bound by its guidelines and that the guidelines may change over time. Your lender may have its own DTI ratio targets and limitations.
I encourage you to consult with a qualified third-party representative who has experience in loan modifications to assist you in determining what your lender’s DTI-ratio targets and limitations are. Although you can negotiate directly with your lender, you really should have representation of your own to protect your interests.
Ralph R. Roberts, GRI, CRS