Front End & Back End Debt To Income Explained

What Is Front End DTI – Back End DTI

Many people meet the Debt to Income (DTI) ratio when they fill documentation for qualifying for a mortgage. The mortgage broker will show some of the lenders limitation and will request them to calculate ‘Back End’ Debt to Income and ‘Front End’ Debt To Income.

In this short review we will explain and give easy examples for these two mortgage definitions, so the process of getting a mortgage or refinancing your mortgage will be more understandable.

Debt To Income Ratio

This DTI ratio is a figure that tell the lender how much money you will owe from your overall gross income. Lenders will want to see how much from the monthly income goes on the mortgage payments (Front-End) and also how much from the monthly income is spend on ALL debts (Back-End) mortgage payments and other fixed payments and expenses.

When people owe too much money from their monthly income, it means they are a risky customers for the lending banks. If the lender determines the Debt to Income limit to 40% and when checking the mortgage request the DTI (Debt to Income) ratio is 50% from their income, it means that:

  • They plan to buy a home which the can not afford.
  • The mortgage length is to short, and needs to be extended.
  • The borrower may be turned down for this request.

Front End Debt To Income Calculation

The calculation for the Front End debt to income is quite easy, DTI ratio needs only two parameters, Income and Mortgage Debts. There are many online calculators you can use, after you understand the principle of the Debt to Income ratio.

  • Income – The best way to calculate the Income factor is to find the annual income based on your last two tax returns, and divide it by 12. It is better to be done like this, as monthly income can vary for self employed unlike salary workers. In the annual income for the DTI is you need the gross income – before taxes.
  • Debts – The Front End’ Debt To Income, measures only the home mortgage expenses, so you need to sum the mortgage payment and add the private mortgage insurance, homeowner’s insurance and property taxes too.

When you divide the Debts by the Income, you get the DTI ratio.

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Front End Debt To Income Ratio Example

If a family annual income is $120,000, and divided by 12, the monthly income is $10,000. The family requested a mortgage for 15 years which the monthly payments where calculated to $3200 per month. This includes the mortgage and the insurance and the property taxes. Their Front End debt to income ratio is 32% (3,200 divided by 10,000).

Back End Debt To Income Calculation

This is the more relevant figure as this figure calculates the real debts of the family. Finding the back-end DTI is simple just like the front-end DTI, except that here all the debts are calculated not only the house financing. here is how the Back-End Debt to Income is calculated:

  • Income – Find the annual gross income before taxes (based on your last two tax returns) and divide it by 12.
  • Debts – Here you need to sum up the house financing debts (mortgage and insurance just like the front end calculation we just did). On top of the mortgage monthly payments ALL the other debts needs to added: Monthly car loan payments, student payments, credit card fixed expenses.

Back End Debt-To-Income Ratio Example

With the same income of $10,000 per month, the Back-End DTI now will be different, as the family has two car loan payments, a student loan and other credit fixed expenses, all their debts sum to $49oo. Now their Back-end debts to income ratio is 49%. This means that nearly 50% of their income is turned to debt payments.

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Qualifying Rate for Debt-to-Income Ratio

Since most lenders require a limit of 45% this family will be denied the mortgage they requested, the payments will be to heavy on the family’s budget and it can be predicted they are a risk for the lender.

The family in this example can either:

  • Search for a cheaper home, as they cannot afford the home they requested the mortgage for.
  • Buy the same home but request a smaller mortgage loan, more cash on hands, so the front-end debt to income will be lower and the back-end will decease too.
  • Or they can extend the 15 years mortgage to a 25 years mortgage, (without changing the mortgage amount) and the monthly payments will decrease to $2200 (front end) and their new back-end debt to income will be 39%.

In cases where the debts are shifting as a result of long term loans like interest only loans where in the first years they borrower pays only the interest and later the principle loan, the lenders will calculate the Back and Front Debt-To-Income by the higher figure and not the current low monthly payments.

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This helps them (and the borrower) be secured from unpleasant surprises where the debt which needs to be paid inflates dramatically in the coming years.

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