Debt-to-income ratio
A qualifying measure that compares what a borrower owes each month to what they earn, shown as a percentage. Lenders use it to gauge whether someone can afford a new loan payment; a lower figure signals more room to repay.
Key Takeaways
- The debt-to-income ratio divides total monthly debt payments by gross monthly income and is stated as a percentage.
- Gross monthly income means earnings before taxes and other deductions come out, not take-home pay.
- The front-end ratio counts only the proposed housing payment; the back-end ratio adds every other recurring debt payment.
- Debt-to-income limits differ by loan product and by lender, and the federal ability-to-repay rule used a back-end ratio of 43 percent or less as its qualified mortgage benchmark.
What It Means
The debt-to-income ratio compares what a borrower is obligated to pay each month against what that borrower earns each month, expressed as a percentage. The math is plain: add up the monthly debt payments, divide by gross monthly income (earnings before taxes and other deductions are taken out), and move the decimal. A borrower with $2,000 in monthly debt payments and $6,000 in gross monthly income has a ratio of about 33 percent.
Underwriters usually look at two versions of the figure. The front-end or Housing Expense Ratio counts only the proposed housing payment. The back-end or Total Debt Ratio counts that housing payment plus every other recurring debt payment, such as a car loan, student loans, and minimum credit card payments. Because the back-end version counts more obligations against the same income, it is never the lower of the two.
The ratio answers one narrow question: does this borrower have room in the monthly budget for a new loan payment? It says nothing about the size of the down payment or the value of the property, which is what the Loan To Value Ratio measures. Limits vary by loan product and by lender.
How It Works in Washington
Debt-to-income limits themselves come from federal rules and from each lender's own overlays. In Washington, though, the person who collects the pay stubs and runs the number is almost always a licensed loan originator working for a Mortgage Broker. The Mortgage Broker Practices Act, chapter 19.146 RCW, defines a mortgage broker as any person who, for direct or indirect compensation or gain, assists a person in obtaining or applying to obtain a residential mortgage loan (RCW 19.146.010). RCW 19.146.200 provides that a person, unless specifically exempted under RCW 19.146.020, may not engage in that business without first obtaining and maintaining a license.
Two Washington duties matter to a borrower watching the ratio. Under RCW 19.146.030, the mortgage broker or loan originator must give the borrower a full written disclosure itemizing and explaining the fees and costs of the loan within three business days after receiving the loan application, which is the document showing the payment the ratio was built on. Under RCW 19.146.0201, it is a violation to make any false or deceptive statement about the rates, points, or other financing terms of a residential mortgage loan. A Washington real estate broker licensed under chapter 18.85 RCW does not qualify borrowers and should never promise a client that a ratio will pass underwriting.
Example
Maria and Dev are getting pre-qualified for a house in Spokane. Their gross monthly income together is $9,000. The loan originator prices the house they like at a $2,250 monthly housing payment covering principal, interest, taxes, and insurance. Their other recurring debts are a $480 car payment, a $310 student loan payment, and $110 in minimum credit card payments, which totals $900 a month.
The front-end ratio is $2,250 divided by $9,000, or 25 percent. The back-end ratio adds the $900, so it is $3,150 divided by $9,000, or 35 percent. They then look at a larger house carrying a $2,700 payment. That moves the front-end ratio to 30 percent and the back-end ratio to $3,600 divided by $9,000, or 40 percent. Working backward from a 43 percent back-end limit, 43 percent of $9,000 is $3,870; subtract the $900 of other debt and the housing payment cannot exceed $2,970. Paying off the car first would free up another $480 of that room.
Common Mistakes and Exam Traps
- Gross monthly income is the denominator in a debt-to-income calculation. An answer built on net or take-home pay is wrong.
- The front-end ratio counts only the housing payment while the back-end ratio counts housing plus all other recurring debt, so the back-end figure is never the smaller of the two.
- A lower debt-to-income percentage is the stronger result. Candidates often reverse this and read a high ratio as a sign of borrowing strength.
- Debt-to-income measures monthly cash flow, not the down payment or the equity in the property. Loan-to-value measures that side of the file.
Where you'll learn this
Frequently Asked Questions
What is the difference between the front-end and back-end debt-to-income ratio?
The front-end ratio divides only the proposed monthly housing payment by gross monthly income. The back-end ratio divides the housing payment plus every other recurring monthly debt payment by that same gross income, so it is the broader test.
Does a Washington real estate broker calculate a buyer's debt-to-income ratio?
No. Qualifying a borrower belongs to the lender and to the loan originator licensed under chapter 19.146 RCW. A real estate broker can refer the buyer to lenders and then let the written pre-approval speak for itself.
Will paying off a car loan improve the ratio?
Retiring a recurring debt removes its payment from the back-end ratio, which lowers the percentage. It also spends cash that may be needed for the down payment and closing costs, so the tradeoff is worth running both ways before closing the account.