By Ralph R. Roberts
RISMEDIA, March 13, 2009-Ask homeowners about their DTI (debt-to-income) ratios, and they’re likely to respond with something like, “My what ratios?!” However, when distressed homeowners are sizing up their foreclosure options, they need to brush up on DTI ratios. Lenders will be scrutinizing these ratios to determine homeowner eligibility for loan modification and other debt relief.
Homeowners need to know that their DTI ratios are crucial to determining an affordable house payment. The current government plan defines an affordable house payment as one that is no higher than 31% of the homeowner’s front-end DTI. In other words, the house payment or PITIA (principal, interest, taxes, insurance, and any association fees) on the first mortgage cannot exceed 31% of the household’s gross monthly income.
Encourage homeowners to examine both their front-end and back-end DTI ratios:
Front-end DTI ratio is based solely on the house payment. (Under the current government plan, the front-end DTI target of 31% accounts only for the first mortgage. If the home has other liens against it, such as a second mortgage or home equity line of credit, those are accounted for separately as part of the back-end DTI.)
Back-end DTI ratio is based on all monthly debt payments combined, including the house payment, credit card payments, payments on auto loans, and other loan payments.
Calculating the Front-End DTI Ratio
Although the formulas for calculating DTI ratios are simple, homeowners are unlikely to have encountered them in the past. To calculate their front-end DTI, instruct homeowners to divide their house payment by their monthly household income (gross income):
House Payment / Gross Monthly Household Income = Front-End DTI Ratio
This is easy, assuming the monthly house payment includes an amount held in escrow to pay the property taxes, homeowner’s insurance, and any association fees. Such a payment is often referred to as PITIA (principal, interest, taxes, insurance, and association fees).
If they pay property taxes, insurance, and association fees separately, then they have to perform an extra step. Instruct them to total these additional annual expenses, divide by 12 months, and add the result to their monthly house payment (principal and interest). They can then divide the resulting house payment by their monthly household income to determine their front-end DTI ratio.
Private mortgage insurance (PMI) payments fall outside this calculation under the current government plan.
Calculating the Back-End DTI Ratio
To calculate the back-end DTI ratio, instruct homeowners to total their monthly debt payments, including: House payment or PITIA, as discussed in the previous section; Any payments on second mortgages, home-equity loans, or home-equity lines of credit; credit card payments; auto loan or lease payments; alimony and other payments on credit accounts or loans.
Now, they should divide their total monthly debt payments by their total gross monthly household income:
Monthly Debt Payments / Gross Monthly Household Income = Back-End DTI Ratio
Exploring DTI Ratios under Obama’s Foreclosure Prevention Plan
The Home Affordable Modification Program accounts for both front-end and back-end DTI ratios. When attempting to reach the 31% target for the front-end DTI, the focus is only on the first mortgage:
For qualifying homeowners, the lender will have to first reduce payments on the first mortgage to no greater than a 38% front-end DTI ratio. Treasury will 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.
Keep in mind that only lenders, investors, and servicers who choose to participate in this program are bound by its guidelines and that the guidelines may change over time. Different lenders may have their own DTI ratio targets and limitations.
When homeowners in your market are in default or in danger of default, encourage them to explore their options. Now that they can calculate their DTI ratios, they have one more tool that will empower them to assess their options, keep their house, and preserve their American Dream of homeownership.
Ralph R. Roberts is a consumer advocate, host of keepmyhouse.com, and author of numerous books, including Foreclosure Self-Defense For Dummies and Loan Modification For Dummies (Summer, 2009). Ralph is based in Sterling Heights, Michigan and can be reached at RalphRoberts@RalphRoberts.com.
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