Back on the 17th of March, I published a blog entry that generated a lot of follow-up questions (see “Understanding Debt-To-Income Ratio“). One such question–and its multiple answers–appears below.

Question: Thank you for your article about DTI ratios. I have a couple of follow up questions. My wife and I own a rental property which has a positive cash flow of $100 per month. Both of our names are on the title and on the loan. On our primary residence, we have a first mortgage and an HOEL. On the primary residence, only my name is on the title and on the loans. I want to calculate our DTIs (Front and Back) for the primary residence. Do I use my wife’s income to calculate both ratios or only mine, since she is not on the loans? Do I use the rental income in calculating both ratios? If yes, do I count only 1/2 since the other 1/2 belongs to my wife? For the Front DTI, I do not include HOEL. Correct? To calculate Back DTI what expenses do I include besides HOEL, second mortgages, credit cards, car loans, other loans? Do I need to include car insurance, utilities, etc. When calculating Back DTI do I only use the minimum amount for the HOEL which is only for the interest amount? Is a rental property considered a liquid asset? ~ Andreas Z.

Great questions, all of them. Here’s what I think (and please keep in mind that I am not an attorney or a Certified Public Accountant):

Question Number 1: Do I use my wife’s income to calculate both ratios or only mine, since she is not on the loans?

Answer: Technically you only need to include your income because you are the only borrower obligated on the note. But realistically you should do both calculations and see how the numbers come out. If your income is not enough to sustain payments without a massive reduction in principal and interest (which may jeopardize your eligibility) you may be able to include some or all of your wife’s income to qualify. This may require that your wife become obligated on the note, so you should consider it very carefully. This also raises the question, what income did the lender use to qualify you for the loan in the beginning? Did the lender use only your income only, or did they include your wife’s as well. If the lender included your wife’s income on the loan, but didn’t include your wife as a co-borrower, I’d question the underwriting process and the ethics of the loan originator. If the loan was applied for and originated with only your income; did you really qualify and was your income accurate on the application? If it was and you did qualify alone, what changed…this may be the hardship you need to fulfill another requirement to receive a loan modification. If you didn’t really qualify, again I’d question the underwriting process.

Question number 2: Do I use the rental income in calculating both ratios? If yes, do I count only 1/2 since the other 1/2 belongs to my wife?

Answer: You only include the debt from the rental unit in your back end ratio. Your gross income is from all sources and yes you would use the rental income figure for both front and back end ratios. As for splitting the income, you should be able to split the positive cash flow. It may be a little more complicated than that though because you have repairs and miscellaneous expenses that go along with a rental, so the $100 a month you are getting now might turn into nothing or a negative cash flow when you have to perform repairs, etc…You should probably look at what you declared as the net rental income on your tax returns or financial statements for the last couple years. I am presuming you offset rental income by renal expenses, so your net rental income might not be anything at all or negligible. If you want to make it simple though you can just put the $50 positive rental income that’s coming in now and disclose it on your financial worksheet.

Question number 3: For the Front DTI, I do not include HOEL. Correct?

Answer: The Obama plan words that a little strangely, but yes. Front end looks at the first lien position, back end includes all debt obligations including subordinate mortgage liens.

Question number 4: To calculate Back DTI what expenses do I include besides HOEL, second mortgages, credit cards, car loans, other loans?

Answer: The regulations that came out on March 4, 2009, list the following obligations as needing to be included in the Back-end DTI (debt-to-income) calculation: All Front-end PITIA plus any mortgage insurance premiums, payments on all installment debts, monthly payments on all junior liens, alimony, car lease payments, aggregate negative net rental income, monthly mortgage payments on second homes.

Question number 5: Do I need to include car insurance, utilities, etc.

Answer: No. The DTI looks at your payment obligations on installment debts. Your overall financial budget should consider these items, but for the DTI calculations no. All items included in the DTI calculations will need to be verified, or what you may have heard called “full documentation”.

Question number 6: When calculating Back DTI do I only use the minimum amount for the HOEL which is only for the interest amount?

Answer: You should include the amount you are obligated to pay each month to avoid defaulting. If the payment calls for $100 per month and is an interest only payment, you should put down $100. If you pay more each month toward principal but are not obligated under the terms of the note to do so, you shouldn’t include that amount. The same goes for credit card balances. If you only have to pay $18/month but pay $150 because you want to pay down the balance and avoid some finance charges, the amount you include for the obligation calculation is $18.

Question number 7: Is a rental property considered a liquid asset?

Answer: Only after you sell it and turn it into cash. It’s real property. It should have been on the schedule of real estate owned on your loan application if you owned it at the time you applied for the loan on the primary. Liquid assets are items like cash, money in checking or savings accounts, money market accounts, stocks/bonds/cd’s and the like. Basically cash or cash substitutes, not a rental house.

Ralph R. Roberts, GRI, CRS Award-Winning REALTOR® and Author Loan Modification For Dummies (avail. Summer 2009)

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
• Alimony
• 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 Award-Winning REALTOR® and Author Loan Modification For Dummies (avail. Summer 2009)