Contributing Writer at Tally
April 12, 2021
When applying for a loan or mortgage, it's easy to stroll into the process with confidence once you build a good credit score. However, you'll quickly find many key factors make up the loan-approval process, including your back-end ratio or back-end debt-to-income (DTI) ratio.
Like your credit score and history, your back-end DTI ratio is an area where you can quickly get a firm approval or denial, as lenders have set guidelines. So, once you determine your lender's requirements, you can know if you'll qualify and what you need to do to qualify.
We'll cover all this and more, but first, let's dive deeper into the question, “What is back-end ratio?”
Your back-end ratio is the total monthly debt obligations you have, including your mortgage and any associated housing debt, relative to your gross income. Gross income is what you earn before deductions and taxes.
Lenders use this ratio to help determine if you can afford a loan or home mortgage comfortably or if it may be a strain on your budget, which is why it’s so important in the approval process.
Some items lenders will include in your back-end ratio are:
Real estate taxes
Homeowners association (HOA) dues
Homeowner's insurance premiums
Credit card payments
Personal loan payments
Auto loan payments
Home equity loan payments
Lines of credit payments
While the list of monthly obligations included in your back-end ratio is long, there are plenty of monthly obligations lenders leave out. The obligations lenders won't consider in your back-end ratio include:
Car insurance premiums
Other general monthly expenses
There's more than just one ratio lenders use when determining your ability to afford a loan or mortgage. Another key one is the front-end DTI ratio. Your front-end DTI ratio only looks at monthly debt obligations related to your home.
Most lenders will include these items in your front-end ratio:
All mortgage payments
Home equity loans
Home improvement loans
Real estate taxes
Calculating your back-end ratio is pretty straightforward. Add all your monthly recurring debts with 10 or more months of payments remaining on them and divide them by your monthly gross income.
Consider you have the following debt payments:
$500 in credit card payments
$300 car loan payment
$1,500 mortgage payment (including property taxes and insurance)
$600 child support payment
You would have $2,900 in monthly debt payments. Now, assume you earn $120,000 per year, which would be $10,000 in gross monthly income. Divide $2,900 by $10,000, and you get 0.29, which is a 29% back-end ratio.
Lenders can use various sources of income to calculate your back-end ratio. Some of the income sources include:
Social Security income
Alimony or child support received
Your back-end ratio can be a make-or-break factor in getting approved for a loan or mortgage. Your credit history is typically the first thing lenders look at, but if they determine you can't afford the loan because your DTI ratio is too high, they’ll likely deny you.
Each lender has differing back-end DTI ratio requirements, and their strictness will often change with your credit score, previous mortgage payment history, surplus monthly income, and more.
For lenders who work with government-backed lending programs, like the Federal Housing Administration (FHA), there are guidelines they must work within. Each lender can still maintain their guidelines as long as they fit within the FHA loan’s minimum requirements.
For example, someone seeking an FHA loan must have a back-end ratio of 43% or less. An individual lender can tighten its FHA restrictions to 40% or lower. However, the lender can't loosen its back-end ratio requirement to 45% without the buyer meeting specific FHA-permitted exceptions, like buying an energy-efficient home or showing additional cash reserves (savings).
If your lender struggles to approve you due to a high back-end DTI, don't throw your hands in the air and give up. There are ways to improve your DTI and get approved.
People with multiple income streams can sometimes forget to list all their income on their loan application. So, review your application carefully and double-check your income listed against your bank statements.
You may find that you forgot to list a portion of your income. Some easily forgotten income may include child support, alimony, cash settlements, cash tips, side-gig pay, and more.
If you get a portion of your pay in cash, such as tips or bonuses, make sure you put this in your bank account so there's a record of it.
Your down payment can make a significant impact on your mortgage payment, which can decrease your back-end DTI. If you have the extra liquid cash to increase your down payment, you may be able to make a significant change in your monthly payment, bringing your back-end DTI under the limit.
If you don't have the extra cash, you can ask a friend or family member to gift you this cash. Just make sure you get a signed "gift" statement from the person stating they don't expect you to repay the money.
When looking at back-end DTI, many lenders combine all borrowers’ income and debts. If your DTI is high, but you have a spouse, friend, or family member whose DTI ratio is low and who's willing to be on the loan with you as a second borrower or a cosigner, this could be enough to get you approved.
Keep in mind, though, if the second borrower or cosigner doesn't have good credit, this could be more harmful than helpful.
If you have several high-interest credit cards or loans, the high payments may be what's driving your back-end DTI ratio so high. By consolidating these debts into a single lower-interest account, you can lower your monthly payment and decrease your DTI ratio.
You have several consolidation options, including:
Debt consolidation loan
Personal line of credit
Home equity loan
Home equity line of credit
Both options work well, but they take different paths toward debt repayment.
The debt avalanche focuses on applying all your extra money toward the debts with the highest interest rate while paying the minimum monthly payment on all your other debts.
Once you pay off the highest-interest account, you apply all your extra cash to the next-highest-interest debt while continuing to make minimum monthly payments on your remaining debts.
This focus on interest rates will save you the most money over time.
The debt snowball applies all your extra funds to the lowest-balance debt while paying the minimum payment on all your other debts. Once you pay off your smallest debt, you put all your extra cash toward your next-smallest debt while making the minimum payments on all other debts.
With its focus on the lowest balances, the debt snowball may cost you more in interest over time. However, its focus on small wins by paying off smaller-balance credit cards is a great motivator.
There is so much focus on building a great credit score in the lending space that it's easy to forget there are other factors. Your back-end ratio is one of these oft-forgotten factors, and it happens to be just as important as your credit score in getting approved.
What's more, back-end ratio is a broad-reaching term that covers a wide range of debts — including personal loan payments, alimony, credit card payments, child support, and more — relative to your gross monthly income. If this ratio is too high for the lender — each lender has its own requirements — or the loan program you're applying for, you can find it tough to get approved, despite having excellent credit.
Fortunately, there are ways to improve your back-end DTI ratio, like finding forgotten income, adding a second borrower or cosigner, increasing your down payment, paying down debt, and consolidating or refinancing your debts.
Tally can help you pay down your back-end DTI with its personal line of credit. The Tally line of credit1 often offers a lower interest rate than your credit cards, allowing you to reduce your debt quicker. You also only make one monthly payment on your debts, and Tally manages all your credit card payments to ensure you don’t incur any late fees or miss a payment.
1To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. The APR (which is the same as your interest rate) Will be between 7.9% - 25.9% per year, and will be based on your credit history. The APR will vary with the market based on the Prime Rate.