Why is this an indicator of how much you can afford?

If I make $10,000/mo, a monthly debt of $4300 (43%) is what I can afford. The remaining $5700 goes towards food, utilities, etc.

Say I get a new job that has an income of $11,000/mo. Since my income has increased $1000/mo, logic would say my monthly debt can increase $1000 to $5300/mo. Food, utilities, etc. have not increased.

But using a debt/income ratio would say $4730/mo.

Good question. It's something that isn't commonly explained but pretty easy to understand. You are attacking it the logical, but wrong way for mortgage purposes.

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If I make $10,000/mo, a monthly debt of $4300 (43%) is what I can afford. The remaining $5700 goes towards food, utilities, etc.

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DTI has front end and back end. Front end is how much of your income is currently going toward housing costs. Back end takes into account all debt obligations (including things like child support).

So if your housing costs are currently $1,250 with an income of $10,000, your front end DTI is 12.5%.

But let's say you also have a car payment of $600, two credit card balances with monthly minimum payment of $250 each, and student loan payment of $450, your back end obligations would be $2,800 and a back end DTI of 28%.

Front end you definitely want to be under 30% and much lower if you can be. Back end you want to be under 35% and much lower if possible.

Mortgage guys please chime in and correct me if I'm wrong.

I need to get on a PC for a good response. Mazzag you are off

mazag08 said:

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Good question. It's something that isn't commonly explained but pretty easy to understand. You are attacking it the logical, but wrong way for mortgage purposes.

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If I make $10,000/mo, a monthly debt of $4300 (43%) is what I can afford. The remaining $5700 goes towards food, utilities, etc.

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DTI has front end and back end. Front end is how much of your income is currently going toward housing costs. Back end takes into account all debt obligations (including things like child support).

So if your housing costs are currently $1,250 with an income of $10,000, your front end DTI is 12.5%.

But let's say you also have a car payment of $600, two credit card balances with monthly minimum payment of $250 each, and student loan payment of $450, your back end obligations would be $2,800 and a back end DTI of 28%.

Front end you definitely want to be under 30% and much lower if you can be. Back end you want to be under 35% and much lower if possible.

Mortgage guys please chime in and correct me if I'm wrong.

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To keep it simple, let's say I have no existing debt, car payments, student loans, etc.

My monthly income goes up $1000/mo. Why can I not now afford $200k more house?

You can exceed 43 DTI.

DTI or Debt to income is nothing more then an accounting method used in mortgage. The 'Top' is gross income and the "bottom' is all minimum debt on the credit report. So PITI plus installments and credit cards. The top is pure gross income before any deductions. The Bottom does not include any non-debt items such as utilities, phone, cable etc.

In the bottom we used to have two parts. So another top and bottom. Here in the debt the housing ratios were max 36%=PITI and total debt with PITI at 43%. But we do not use this breakdown anymore. So we just look at total debt. It is also no longer 43% max and for the most part 50%. FHA will go slightly higher then 50 but for practical purposes 50% is good number.

So for the OP with 10K gross income and no other debt PITI must stay at a max of 5000 per month.

Of course the real max housing payment you can afford is what you can sleep at night knowing you will have to write a check every month. I usually work up from what my clients are paying now. If they are paying 1500 in rent I start in that range and work up incrementally to see what they are comfortable with. It is always less then max approval I can get

Ill stand corrected. I was still under the impression it worked in the way a I wrote up.

I still don't get why debt/income is the indicator used. If I get a $1000/mo raise, I should be able to afford $1000/mo more monthly payment. But the bank says - no, only 43-50% of that. Why? All of my other expenses (food, gas, utilities) remain the same.

Martin Q. Blank said:

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I still don't get why debt/income is the indicator used. If I get a $1000/mo raise, I should be able to afford $1000/mo more monthly payment. But the bank says - no, only 43-50% of that. Why? All of my other expenses (food, gas, utilities) remain the same.

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Maybe the bank is assuming your obligations will update with your income. I don't know.

the lender wants to sell at least the money part of the loan to use on another future loan. Whether we sell to Fannie, Freddie, FHA VA whoever they have investor rules at what they buy and what they wont. Lenders have to "conform" to their rules. So DTI limits are driven from this sell/purchase.

Or you can say the man who has the gold gets to make the rules.

Also the investors have huge amounts of loss data and it is possible that their past data shows increase in losses for the higher the DTI is in the file

43% to 50% back ratios are there for a reason. Mainly because in real estate transactions, lenders are the only ones that seem to take emotions out of the equation. Bott speaks the truth. There are volumes of data that reflect a direct correlation in defaults in the conforming brackets when back ends above 50% DTI are exceeded.

Deats99 said:

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43% to 50% back ratios are there for a reason. Mainly because in real estate transactions, lenders are the only ones that seem to take emotions out of the equation. Bott speaks the truth. There are volumes of data that reflect a direct correlation in defaults in the conforming brackets when back ends above 50% DTI are exceeded.

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Just out of curiosity where did the data come from if conventional has been capped at 50 and fha at 57?

Were the ratios actually once higher pre S&L crisis ?

Or is the data skewed from pre 2008 and stated income loans/ Sub prime ?

Higher then 50% was allowed up to around 2012 or so. 55 was usually the limit then but other factors go into data. Credit score, type of income, type of home i.e. Vacation home.

Conventional dropped overnight to 45 but has gone back up to 50 the last year or two.

All good and correct by the lenders on the board. Just as an aside, VA is the most liberal when it comes to DTI. Member of my organization closed a VA last year with a DTI in the high 70's! They won the inaugural "Most Likely to Default" award at the company Christmas party.

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In the bottom we used to have two parts. So another top and bottom. Here in the debt the housing ratios were max 36%=PITI and total debt with PITI at 43%. But we do not use this breakdown anymore.

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So Bott, was I correct in my post above as to the way it USED to be? It sounds like the industry has moved to taking on more risk than say.. 2010.

I always advise my clients to add up their total debt obligations and not aim for a PITI that would put you over 35%, especially considering most are younger married couples still hoping to have kids.

If that's bad advice I'd appreciate knowing.

KC_Ag14 said:

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All good and correct by the lenders on the board. Just as an aside, VA is the most liberal when it comes to DTI. Member of my organization closed a VA last year with a DTI in the high 70's! They won the inaugural "Most Likely to Default" award at the company Christmas party.

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VA is different because it does not rely on DTI. It actually uses a residual calculation based on family size and geographic local.

Wanted to clarify. I am sure you know the difference. I wanted to share that for those that did not, lol

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It actually uses a residual calculation based on family size and geographic local.

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This makes more sense to me. Food, utilities, etc. cost a lot more in San Francisco than Tulsa.

Mazz the 36/43 bottom is really old school manual underwriting that we have not really used even before my time starting 2002. It was mostly used by FHA back in the day. Now we submit to a software portal and that software gives us an approval based on data input. We then confirm our input with supporting docs to a human. Basically we use automated underwriting instead of manual in almost all loans. I've not done a manual in over 10 years. You only go manual with truly unique files like no credit file borrowers. The automated software can be adjusted on the back end for what investors are looking for.

VA is a strange bird but very lenient in its ratios. Very old school. They give much more room to get them done and really designed as a benefit for veterans. It's a really good program for them and gets a lot of folks started in home ownership

SteveBott said:

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Mazz the 36/43 bottom is really old school manual underwriting that we have not really used even before my time starting 2002. It was mostly used by FHA back in the day. Now we submit to a software portal and that software gives us an approval based on data input. We then confirm our input with supporting docs to a human. Basically we use automated underwriting instead of manual in almost all loans. I've not done a manual in over 10 years. You only go manual with truly unique files like no credit file borrowers. The automated software can be adjusted on the back end for what investors are looking for.

VA is a strange bird but very lenient in its ratios. Very old school. They give much more room to get them done and really designed as a benefit for veterans. It's a really good program for them and gets a lot of folks started in home ownership

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Thanks for clearing that up.

Martin Q. Blank said:

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I still don't get why debt/income is the indicator used. If I get a $1000/mo raise, I should be able to afford $1000/mo more monthly payment. But the bank says - no, only 43-50% of that. Why? All of my other expenses (food, gas, utilities) remain the same.

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The banks use a blanket societal assumption and for the most part if a person maxed out their DTI budget when buying a house they don't have much wiggle room for error and are possible already over extended on debt. Like Steve said most people can be approved for a much higher mortgage than the feel like the can afford. Also do you really believe most people would get a 10% raise and not change spendings habits?

Conversely, take your logic and now implement a pay cut instead of a pay raise. The argument crumbles.

You have tax obligations, responsible people have savings obligations and charitable obligations and standard of living obligations. DTI is calculated based upon gross income so you don't actually have $1000 more to spend towards debt and the average individual is not going to allocate the entirety of that increase to debt.

Imagine you have income of $0 and increase to $100. By your argument the entirety of the $100 should be allowable as a debt obligation. Imagine you make $3,000 and increase to $4,000 that would be a 33% increase in your monthly debt obligation without a 33% increase in your take home income.

Why do mortgages require a 50% DTI cap? Because it has been determined that the likelihood of repayment falls at a faster rate after that threshold. If you have obligations greater than 50% you're playing a really, really risky game.

Mortgage companies can merely grab a snapshot of your life. They know you're using a specific amount of debt, but they don't know the amount of cash you are spending in addition to that. They don't analyze the annual increase in debt obligation either. So while you may have been able to pay for significant proportion of your life in cash, perhaps that number is increasing.

50% may be a conservative number for some or a substantial risk for default for others. It depends on how you TRULY manage your money. It's just a shortcut to weed out the truly financially inept.

I can't imagine spending ~50% post-tax monthly income on housing

Is this common?

Martin Q. Blank said:

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I still don't get why debt/income is the indicator used. If I get a $1000/mo raise, I should be able to afford $1000/mo more monthly payment. But the bank says - no, only 43-50% of that. Why? All of my other expenses (food, gas, utilities) remain the same.

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Here's my experience. When income rises so does debt. $400/month car payments become $1,100/month car payments. Add in a boat, maybe an RV, house at the lake.

I find the most difficult DTI situations are borrowers with $200K/year income and up.

Not normally, it is all the bells and whistles that come with the lifestyle. The Caddy for the wife, the new Superduty, the boat, the side by side the, the time share........

It does not happen often and almost always an undocumented income involved.

1. Spouse working but not on the application due to credit scores.

2. Buying a home before selling the current one.

3. Other income not being counted such as a bonus

Martin Q. Blank said:

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I still don't get why debt/income is the indicator used. If I get a $1000/mo raise, I should be able to afford $1000/mo more monthly payment. But the bank says - no, only 43-50% of that. Why? All of my other expenses (food, gas, utilities) remain the same.

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So you're saying the guy who makes $4k a month spends the same amount on restaurants and food than the guy who makes $15k a month? Because that's what you're saying. That an increase in income doesn't translate to an increase in spending.

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Say I get a new job that has an income of $11,000/mo. Since my income has increased $1000/mo, logic would say my monthly debt can increase $1000 to $5300/mo. Food, utilities, etc. have not increased.

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Again, can you say that your 'food, utilities, etc' haven't increased since your first job out of college? Because that's what you're basically saying.

62strat said:

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Martin Q. Blank said:

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I still don't get why debt/income is the indicator used. If I get a $1000/mo raise, I should be able to afford $1000/mo more monthly payment. But the bank says - no, only 43-50% of that. Why? All of my other expenses (food, gas, utilities) remain the same.

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So you're saying the guy who makes $4k a month spends the same amount on restaurants and food than the guy who makes $15k a month? Because that's what you're saying. That an increase in income doesn't translate to an increase in spending.

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Say I get a new job that has an income of $11,000/mo. Since my income has increased $1000/mo, logic would say my monthly debt can increase $1000 to $5300/mo. Food, utilities, etc. have not increased.

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Again, can you say that your 'food, utilities, etc' haven't increased since your first job out of college? Because that's what you're basically saying.

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Not since college. Since yesterday. Say I get a promotion, or change jobs, or inherit a side business. I all of a sudden have an increase of $1000/mo. So yes, my food, utilities, etc. would remain the same.

Martin Q. Blank said:

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62strat said:

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Martin Q. Blank said:

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I still don't get why debt/income is the indicator used. If I get a $1000/mo raise, I should be able to afford $1000/mo more monthly payment. But the bank says - no, only 43-50% of that. Why? All of my other expenses (food, gas, utilities) remain the same.

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So you're saying the guy who makes $4k a month spends the same amount on restaurants and food than the guy who makes $15k a month? Because that's what you're saying. That an increase in income doesn't translate to an increase in spending.

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Say I get a new job that has an income of $11,000/mo. Since my income has increased $1000/mo, logic would say my monthly debt can increase $1000 to $5300/mo. Food, utilities, etc. have not increased.

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Again, can you say that your 'food, utilities, etc' haven't increased since your first job out of college? Because that's what you're basically saying.

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Not since college. Since yesterday. Say I get a promotion, or change jobs, or inherit a side business. I all of a sudden have an increase of $1000/mo. So yes, my food, utilities, etc. would remain the same.

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Oh, I see, so only if you just got the promotion yesterday do all your existing expenditures stay the same. What about in 2 days? or 2 weeks?

What about 6 months? What about 5 years? How long after a raise exactly do you propose the lender assumes your expenditures begin to increase?

Do you see how this argument falls apart pretty quickly?