Front End Ratio
The measure of an individual's ability to pay is through Ratio's. Front end ratio is the sum of your monthly mortgage payment including taxes and insurance (principal, interest, taxes, and insurance or PITI) as a percentage of your gross monthly income. For example: if you make $5000 per month and your PITI is $1000, your front end ratio is 20%
Back End Ratio
The back end ratio is otherwise known as debt to income ratio (DTI). DTI assesses your debt repayments as a proportion of your total monthly income. Car loans, personal loans, credit card debt payments, student loans, etc are added to your projected mortgage figure to figure out how much new debt you can afford. In order to calcualte DTI, take the sum of all of your monthly debt payments and divide that figure with your monthly income.
Example: Lets say you have a gross monthly income of $10,000. You are applying for a loan with a lender for $100,000 and your projected monthly amortized payment for this new loan is $2000. You also have existing monthly debt payment of $1000. The lender will include the expected $2000 debt payment (mortgage payments) to your existing $1000 debt payment when caluclating DTI:
1000+2000/10,000 = 30% DTI
The DTI ratio is very improtant as lenders use it to assess your ability to cover loan payments and other debt obligations. Lenders will typically only lend up to 43-50% of your gross income, meaning that your combined monthly loan payments cannot exceed max 50% DTI ratio. Click here for DTI Calculator
Can you lower your DTI? Absolutely! It is easier and quicker than improving your credit score, but it does require a major shift in your way of thinking.