In the consumer mortgage industry, debt-to-income ratio (often abbreviated DTI) is the percentage of a consumer's monthly
gross income that goes toward paying debts. (Speaking precisely, DTIs often cover more than just debts; they can include principal, taxes, fees, and insurance premiums as well. Nevertheless, the term is a
set phrase
Set, The Set, SET or SETS may refer to:
Science, technology, and mathematics Mathematics
*Set (mathematics), a collection of elements
*Category of sets, the category whose objects and morphisms are sets and total functions, respectively
Electro ...
that serves as a convenient, well-understood shorthand.) There are two main kinds of DTI, as discussed below.
Two main kinds of DTI
The two main kinds of DTI are expressed as a pair using the notation
(for example, 28/36).
# The first DTI, known as the ''front-end ratio'', indicates the percentage of income that goes toward housing costs, which for renters is the rent amount and for homeowners is
PITI
Piti may refer to:
* Pīti, a mental factor in Buddhism
* PITI, the principal, interest, taxes, and insurance sum of a mortgage payment
* Piti (food), a soup dish of Central Asia
* Piti (footballer) (born 1981), Spanish footballer
* Piti, Guam
* Pi ...
(
mortgage
A mortgage loan or simply mortgage (), in civil law jurisdicions known also as a hypothec loan, is a loan used either by purchasers of real property to raise funds to buy real estate, or by existing property owners to raise funds for any ...
principal and
interest
In finance and economics, interest is payment from a borrower or deposit-taking financial institution to a lender or depositor of an amount above repayment of the principal sum (that is, the amount borrowed), at a particular rate. It is distin ...
,
mortgage insurance
Mortgage insurance (also known as mortgage guarantee and home-loan insurance) is an insurance policy which compensates lenders or investors in mortgage-backed securities for losses due to the default of a mortgage loan. Mortgage insurance can be ...
premium
hen applicable hazard insurance premium,
property tax
A property tax or millage rate is an ad valorem tax on the value of a property.In the OECD classification scheme, tax on property includes "taxes on immovable property or net wealth, taxes on the change of ownership of property through inhe ...
es, and
homeowners' association dues
hen applicable.
# The second DTI, known as the ''back-end ratio'', indicates the percentage of income that goes toward paying all recurring debt payments, including those covered by the first DTI, and other debts such as
credit card
A credit card is a payment card issued to users (cardholders) to enable the cardholder to pay a merchant for goods and services based on the cardholder's accrued debt (i.e., promise to the card issuer to pay them for the amounts plus the o ...
payments, car loan payments, student loan payments, child support payments, alimony payments, and legal judgments.
Example
If the lender requires a debt-to-income ratio of 28/36, then to qualify a borrower for a mortgage, the lender would go through the following process to determine what expense levels they would accept:
*Using Yearly Figures:
**Gross Income of $45,000
**$45,000.28 = $12,600 allowed for housing expense.
**$45,000.36 = $16,200 allowed for housing expense plus recurring debt.
*Using Monthly Figures:
**Gross Income of $3,750 (=)
**$3,750.28 = $1,050 allowed for housing expense.
**$3,750.36 = $1,350 allowed for housing expense plus recurring debt.
DTI limits used in qualifying borrowers
United States
Conforming loans
In the United States, for
conforming loans, the following limits are currently typical:
* Conventional financing limits are typically 28/36 for manually underwritten loans. The maximum can be exceeded up to 45% if the borrower meets additional credit score and reserve requirements.
*
FHA limits are currently 31/43.
When using the FHA's
Energy Efficient Mortgage An energy efficient mortgage (EEM) (or "green mortgage") is a loan product that allows borrowers to reduce their utility bill costs by allowing them to finance the cost of improving the energy-efficiency of the real estate property, at the point of ...
program, however, the "stretch ratios" of 33/45 are used
*
VA loan A VA loan is a mortgage loan in the United States guaranteed by the United States Department of Veterans Affairs (VA). The program is for American veterans, military members currently serving in the U.S. military, reservists and select surviving s ...
limits are only calculated with one DTI of 41. (This is effectively equal to 41/41, although VA does not use that notation.)
* USDA 29/41
Nonconforming loans
Back ratio limits up to 55 became common for
nonconforming loans in the 2000s, as the
financial industry
Financial services are the economic services provided by the finance industry, which encompasses a broad range of businesses that manage money, including credit unions, banks, credit-card companies, insurance companies, accountancy companies, ...
experimented with looser credit, with innovative terms and mechanisms, fueled by a
real estate bubble
A real-estate bubble or property bubble (or housing bubble for residential markets) is a type of economic bubble that occurs periodically in local or global real-estate markets, and typically follow a land boom. A land boom is the rapid increase ...
. The mortgage business underwent a shift as the traditional mortgage banking industry was shadowed by an infusion of lending from the
shadow banking system
The shadow banking system is a term for the collection of non-bank financial intermediaries (NBFIs) that provide services similar to traditional commercial banks but outside normal banking regulations. Examples of NBFIs include hedge funds, ins ...
that eventually rivaled the size of the conventional financing sector. The
subprime mortgage crisis produced a
market correction
A market correction is a rapid change in the nominal price of a commodity, after a barrier to free trade has been removed and the free market establishes a new equilibrium price. It may also refer to several of these single-commodity corrections ...
that revised these limits downward again for many borrowers, reflecting a predictable tightening of credit after the laxness of the
credit bubble
An economic bubble (also called a speculative bubble or a financial bubble) is a period when current asset prices greatly exceed their intrinsic valuation, being the valuation that the underlying long-term fundamentals justify. Bubbles can be ...
. Creative financing (involving riskier ratios) still exists, but nowadays is granted with tighter, more sensible qualification of customers.
Historical limits
The business of lending and borrowing money has evolved qualitatively in the post–World War II era. It was not until that era that the
FHA and the
VA (through the
G.I. Bill
The Servicemen's Readjustment Act of 1944, commonly known as the G.I. Bill, was a law that provided a range of benefits for some of the returning World War II veterans (commonly referred to as G.I.s). The original G.I. Bill expired in 1956, bu ...
) led the creation of a mass market in 30-year, fixed-rate, amortized mortgages. It was not until the 1970s that the average working person carried credit card balances (more information at
Credit card#History). Thus the typical DTI limit in use in the 1970s was PITI<25%, with no codified limit for the second DTI ratio (the one including credit cards). In other words, in today's notation, it could be expressed as 25/25, or perhaps more accurately, 25/NA, with the NA limit left to the discretion of lenders on a case-by-case basis. In the following decades these limits gradually climbed higher, and the second limit was codified (coinciding with the evolution of modern
credit scoring
A credit score is a numerical expression based on a level analysis of a person's credit files, to represent the creditworthiness of an individual. A credit score is primarily based on a credit report, information typically sourced from credit bu ...
), as lenders determined empirically how much risk was profitable. This empirical process continues today.
Canada
The Vanier Institute of the Family measures debt to income as total family debt to net income. This is a different ratio, because it compares a cashflow number (yearly after-tax income) to a static number (accumulated debt) - rather than to the debt payment as above. The Institute reported on February 17, 2010 that the average Canadian Family owes $100,000, therefore having a debt to net income after taxes of 150%
United Kingdom
The Bank of England (as of June 26, 2014) implemented a debt to income multiplier on mortgages of 4.5 (A consumer mortgage can be 4.5 times the size of annual income), in an attempt to cool rapidly rising house prices. Previously internal standards were relied upon in order to assess the risk of defaults however in the wake of the 2008 financial crisis it was decided that the risk of contagion between housing markets was too great in order to rely solely on voluntary regulation.
Reuters
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References
Mortgage industry of the United States
Financial ratios