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Debt to Income Ratio

Definition

A debt income ratio is the percentage of a consumer's monthly gross income that goes toward paying debts. There are two main kinds of DTI, as discussed below.

The Debt to Income ratio is the formula to help lenders in estimating the amount of money they should lend out. This figure takes into account the value and frequency of long term debt that a borrower has accrued.

In simple words, a Debt to Income ratio is the percentage of an individual’s gross monthly income that is spent in repaying debts. However, the Debt to Income Ratio does not just cover debts, but also fees, insurance premium and taxes.

How DTI is used

Lenders carefully consider the DTI of a borrower in order to analyze and assess their financial history, before lending money to them. The lower the value of DTI a borrower has, the better the chances to get a loan.

In order to calculate a borrower’s Debt to income ratio, lenders use a simple method: Firstly, the borrower’s existing debt payments are carefully examined, as well as the projected payments for the new loan they have applied for.

The lender then makes an approximate calculation of the total percentage that portrays the borrower’s income before the deduction of taxes. This percentage signifies the DTI, which serves as an important factor in determining the approval and extension of a loan.

DTI and its types

There are two major types of Debt to Income Ratio which are expressed in the form of a pair.

  • Front end Debt to Income ratio
  • Back end Debt to Income ratio

The front end Debt to Income ratio represents the percentage of a consumer’s earnings that are spent in housing. This includes all the costs of housing and living; the rent, the mortgage payment, the maintenance, the insurance, association fees and all applicable taxes.

The second type of DTI which is the back end ratio represents the percentage of a consumer’s income that is spent in the repayment of debts plus all those included in the front end ratio. It also includes other debts like credit card billings, student loan payments, car leasing payments, any legal owing, alimony payments, and other form of arrears.


Further Reading


Portfolio choice and the debt-to-income relationship
www.nber.org [PDF]
… The research reported here is part of the NBER'S research program in Financial Markets and Monetary Economics. Any opinions expressed are those of the author and not those of the National Bureau of Economic Research. Page 2 … relatively stable debt-to—income ratio …

The growth of US household debt: Demand-side influencesThe growth of US household debt: Demand-side influences
www.sciencedirect.com [PDF]
… The research reported here is part of the NBER'S research program in Financial Markets and Monetary Economics. Any opinions expressed are those of the author and not those of the National Bureau of Economic Research. Page 2 … relatively stable debt-to—income ratio …

Household debt and financial assets: evidence from Germany, Great Britain and the USAHousehold debt and financial assets: evidence from Germany, Great Britain and the USA
rss.onlinelibrary.wiley.com [PDF]
… The research reported here is part of the NBER'S research program in Financial Markets and Monetary Economics. Any opinions expressed are those of the author and not those of the National Bureau of Economic Research. Page 2 … relatively stable debt-to—income ratio …

Financial variables associated with successful debt liquidationFinancial variables associated with successful debt liquidation
onlinelibrary.wiley.com [PDF]
… The research reported here is part of the NBER'S research program in Financial Markets and Monetary Economics. Any opinions expressed are those of the author and not those of the National Bureau of Economic Research. Page 2 … relatively stable debt-to—income ratio …

Debt and economic activity in the United StatesDebt and economic activity in the United States
www.nber.org [PDF]
… The research reported here is part of the NBER'S research program in Financial Markets and Monetary Economics. Any opinions expressed are those of the author and not those of the National Bureau of Economic Research. Page 2 … relatively stable debt-to—income ratio …

A Degree of Practical Wisdom: The Ratio of Educational Debt to Income as a Basic Measurement of Law School Graduates' Economic ViabilityA Degree of Practical Wisdom: The Ratio of Educational Debt to Income as a Basic Measurement of Law School Graduates' Economic Viability
heinonline.org [PDF]
… The research reported here is part of the NBER'S research program in Financial Markets and Monetary Economics. Any opinions expressed are those of the author and not those of the National Bureau of Economic Research. Page 2 … relatively stable debt-to—income ratio …

Household debt burden and financial vulnerability in LuxembourgHousehold debt burden and financial vulnerability in Luxembourg
ideas.repec.org [PDF]
… The research reported here is part of the NBER'S research program in Financial Markets and Monetary Economics. Any opinions expressed are those of the author and not those of the National Bureau of Economic Research. Page 2 … relatively stable debt-to—income ratio …

Is there a debt service channel of monetary transmission?Is there a debt service channel of monetary transmission?
papers.ssrn.com [PDF]
… The research reported here is part of the NBER'S research program in Financial Markets and Monetary Economics. Any opinions expressed are those of the author and not those of the National Bureau of Economic Research. Page 2 … relatively stable debt-to—income ratio …

Household debt and income inequality, 1963–2003Household debt and income inequality, 1963–2003
onlinelibrary.wiley.com [PDF]
… The research reported here is part of the NBER'S research program in Financial Markets and Monetary Economics. Any opinions expressed are those of the author and not those of the National Bureau of Economic Research. Page 2 … relatively stable debt-to—income ratio …



Q&A About Debt to Income Ratio


How do you calculate debt to income ratios?

To calculate DTIs, you take all of your monthly expenses (including principal, taxes, fees, and insurance premiums) and divide them by your gross monthly income. The resulting number is then expressed as a percentage. For example, if you earn $2,000 per month in gross income and have $1,500 in expenses (principal + interest + taxes + insurance), then your DTI would be 66%.

What does the front end ratio include?

The front end ratio includes all costs of housing and living; rent, mortgage payment, maintenance, insurance, association fees and applicable taxes.

What is the difference between a back ratio and a front ratio?

Back ratios are those that come after your monthly payments, while front ratios are those before your monthly payments.

What are two major types of Debt to Income Ratios that are expressed as pairs?

Front End and Back End ratios.

What does the back end ratio include?

The back end ratio includes other debts like credit card billings, student loans and car loans.

How do lenders use this information?

Lenders carefully consider the DTI of a borrower in order to analyze their financial history before lending money to them.

What does it mean when lenders require 2836 or 36% for their loans?

It means that they will only accept borrowers who spend no more than 36% of their gross incomes on housing costs (mortgage payment plus utilities).

What is the formula for a Debt to Income Ratio?

The formula for a Debt to Income Ratio is DTI = Total debt payments / Gross monthly income.