Debt to Income (DTI) ratios is an important real estate math concept that you will need to know for your real estate licensing exam. When your buyers are getting a loan, one of the major factors to qualifying for a loan will be their debt to income ratios (DTI). Here’s what you need to know:
There are two types of DTI ratios:
- The Front End Ratio is calculated as the percentage of income that will go towards the homeowner’s future PITI (Principal, Interest, Taxes, and Insurance). Essentially, the bank wants to check that your buyer’s mortgage payment isn’t going to eat up all of their income and that they will have enough for other living expenses.
- The Back End Ratio is calculated as the percentage of income that goes towards all of their debts, including the future PITI, school loans, car payments, credit card payments, etc. Again, the bank wants to know that your buyer is not already so far in debt that they cannot afford their mortgage payment.
Most banks have a set front-end and back-end DTI ratios that they use as lending guidelines. In the US, the typical ratios are 0.28 for the front end, and .36 for the back end. This means that a buyer’s future PITI payment cannot exceed 28% of their monthly income and their total debt (including the future PITI payment) cannot exceed 36% of their monthly income.
On the real estate licensing exam, a common real estate math problem that you may encounter will be to calculate a buyer’s front end or back end ratio. Another common real estate math exam question will be to calculate the maximum PITI payment based on a buyer’s monthly income and current debt amounts.
Real Estate Math Example
Question: Doug has a monthly income of $3000. What is the maximum PITI that Doug can pay using the 0.28 front-end DTI ratio?
Answer: To get the maximum PITI, you multiple $3000 x 0.28 = $840/month. Doug can afford a maximum PITI of $840/month.
Question: Doug decides to buy a new car before he buys a house and incurs a $50/month debt. Can Doug still afford a $840/month mortgage payment?
Answer: First, we calculate Doug’s back-end DTI ratio, which is ($840+$50)/$3000 = 0.30. Since this ratio is less than the typical 0.36 back-end DTI, Doug can still afford the $840/month PITI payment.
For more real estate math practice, check our 125 Real Estate Math Problems Solved Workbook and Solutions Manual. Bonus video explanations of all questions are also included!