With all the recent government programs available to homeowner’s facing potential foreclosure, understanding debt-to-income ratio is more important than ever, as lenders will be utilizing this parameter to determine your eligibility.

Debt-to-income ratio is a simple formula, calculated based on several key elements of a homeowner’s incoming salary versus outgoing expenses. There are two different types of DTI ratios, front-end and back-end, both of which may be used by lenders. Front-end DTI ratio is based solely on the house payment, while the back-end value is based on all monthly debt payments combined. DTI ratios are an integral part of  evaluating what constitutes an affordable house payment for an individual (or family), so it is important for consumer’s to understand how they are determined.

The front-end DTI ratio limit for the most recent government plan is 31%. This means that the house payment (including principal, interest, taxes, insurance, and any association fees) on the first mortgage cannot exceed 31% of the household’s gross monthly income. The calculation is simply this:

Front-End DTI Ratio= House Payment / Gross Monthly Household Income

Back-end DTI ratio is the total of ALL outgoing payments  (house payment including PITIA plus any payments on credit cards,  second mortgages, home-equity loans, or home-equity lines of credit; credit card payments; auto loan or lease payments; alimony, etc.) thus the formula is:

Back-End DTI Ratio= Total Monthly Payments / Gross Monthly Household Income

Under President Obama’s “Making Homes Affordable Modification Program” qualifying homeowner’s will need to account for both front-end and back-end DTI ratios. The process will consist of a workout plan to reach the 31% target for the front-end DTI, focusing only on the first mortgage,  and lenders will have to first reduce payments on the mortgage to no greater than a 38% front-end DTI ratio. The Treasury will then match further reductions in monthly payments dollar-for-dollar with the lender/investor, down to a 31% 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%, 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.

Naturally, the requirements for DTI may vary between lenders thus these parameters are subject to change. Understanding your options if you are considering refinancing or applying for loan modification under a government or other program is a valuable asset, and we encourage homeowners to explore all options if you are potentially facing foreclosure.

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