Calculations used by lenders to determine if a borrower can qualify for a mortgage, and furthermore, the largest mortgage that home buyer can afford. The calculations typically used to determine these things are the ratio of monthly housing costs to monthly income, and the ratio of all monthly debt to monthly income.

Qualifying Ratios are more commonly known as Debt to Income Ratio's or DTI.

Front End Ratio

The front end ratio in relation to mortgage is the housing debt in relation to the income.

Back End Ratio

The back end ratio in relation to mortgage is the combined monthly expenses (car, mortgage, credit cards) in relation to the borrower's monthly income.

Calculating DTI

Two Important Factors in Calculating DTI are:

1. Monthly income "pre-tax" is used

2. The debt is calculated using the fixed monthly expenses appearing on the borrower’s credit report. This means things like the electric bill, car insurance, and monthly cell phone bill are excluded from the calculation.

Calculating Front End DTI:

Example: Borrower has a monthly pre-tax income of $10,000

Monthly Housing Payment (PITI) = $2,000

Front End DTI = Housing Payment / Monthly Pre-Tax Income

2,000 / 10,000 = 20%

Front End DTI = 20%

Calculating Back End DTI:

Example: Borrower has a monthly pre-tax income of $10,000 Borrower's expenses are as follows:

Housing Payment: $2,000

Car Payment: $500

Credit Card A: $100

Credit Card B: $100

Total $2,700

DTI = Debt/Income, 2700/10000 = 27%

Bankapedia's Take

DTI is one of the most common areas of fraud in the business. As home prices grew, people’s greed did as well. More often than not the price level of a home someone wants is determined not by their own common sense, but by the max allowable DTI. Fraud commonly took the form of photo-shopped Income Documentation and falsified pay stubs. Stated Income loans only made the problem worse, with more often than not borrowers overstating their income, or in many cases over zealous loan officers overstating the income for their borrowers. Tighter lending guidelines and their near erasure of stated loans have brought most of these issues back down to earth.