Standard Debt to Income Ratio
The debt-to-income ratio actually consists of two ratios, the front-end ratio and the back-end ratio. Mortgage lenders use these ratios as tools to determine how large a mortgage you will be able to handle. The lower your debt-to-income ratio, the easier it will be for you to make you debt payments. There is no hard and fast rule for what this ratio should be, but there are some generally accepted guidelines.
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Front-End Ratio
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The front-end ratio is the ratio of your monthly mortgage payments to your gross, or pre-tax, monthly income. The standard front-end ratio is 28 percent or lower. This means that you would be spending 28 percent of your pre-tax monthly income on your mortgage and have 72 percent of your income for the rest of your expenses and savings.
Back-End Ratio
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To calculate the back-end ratio, first add all of your monthly debt obligations, such as credit card payments, student loans, car payments and personal loans, to your monthly mortgage payment. The back-end ratio is the ratio of your total debt obligations to your pre-tax monthly income. The current standard is 36 percent or lower. At this ratio, you would be spending just over a third of you income on debt service.
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Historical Value
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During the 1970's, the standard debt-to-income ratio was closer to 22 or 25 percent compared to the current value. The 2011 debt-to-income ratio limit for Federal Housing Association loans is 33 percent for the front-end ratio and 43 percent for the back-end ratio. Robb Severdia suggested in 2008, that this relaxing of the debt-to-income ratio requirements may be a result of more banks competing for loans.
Considerations
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The standard debt-to-income ratio represents the maximum ratio you may have and still qualify for a loan. This does not mean that the ratio that is right for you. The lower your ratio, the more money you will have available for living expenses, savings and other activities. Additionally, the ratio does not account for unusual, non-debt expenses. For example, if you have regular medical expenses, or another extra expense, you may need to set a lower ratio for yourself.
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References
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