Answering Questions about Front and Back DTI Calculations

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Back on the 17th of March, I published a blog entry that generated a lot of follow-up questions (see “Understanding Debt-To-Income Ratio“). One such question–and its multiple answers–appears below.

Question: Thank you for your article about DTI ratios. I have a couple of follow up questions. My wife and I own a rental property which has a positive cash flow of $100 per month. Both of our names are on the title and on the loan. On our primary residence, we have a first mortgage and an HOEL. On the primary residence, only my name is on the title and on the loans. I want to calculate our DTIs (Front and Back) for the primary residence. Do I use my wife’s income to calculate both ratios or only mine, since she is not on the loans? Do I use the rental income in calculating both ratios? If yes, do I count only 1/2 since the other 1/2 belongs to my wife? For the Front DTI, I do not include HOEL. Correct? To calculate Back DTI what expenses do I include besides HOEL, second mortgages, credit cards, car loans, other loans? Do I need to include car insurance, utilities, etc. When calculating Back DTI do I only use the minimum amount for the HOEL which is only for the interest amount? Is a rental property considered a liquid asset? ~ Andreas Z.

Great questions, all of them. Here’s what I think (and please keep in mind that I am not an attorney or a Certified Public Accountant):

Question Number 1: Do I use my wife’s income to calculate both ratios or only mine, since she is not on the loans?

Answer: Technically you only need to include your income because you are the only borrower obligated on the note. But realistically you should do both calculations and see how the numbers come out. If your income is not enough to sustain payments without a massive reduction in principal and interest (which may jeopardize your eligibility) you may be able to include some or all of your wifes income to qualify. This may require that your wife become obligated on the note, so you should consider it very carefully. This also raises the question, what income did the lender use to qualify you for the loan in the beginning? Did the lender use only your income only, or did they include your wifes as well. If the lender included your wifes income on the loan, but didnt include your wife as a co-borrower, Id question the underwriting process and the ethics of the loan originator. If the loan was applied for and originated with only your income; did you really qualify and was your income accurate on the application? If it was and you did qualify alone, what changedthis may be the hardship you need to fulfill another requirement to receive a loan modification. If you didnt really qualify, again Id question the underwriting process.

Question number 2: Do I use the rental income in calculating both ratios? If yes, do I count only 1/2 since the other 1/2 belongs to my wife?

Answer: You only include the debt from the rental unit in your back end ratio. Your gross income is from all sources and yes you would use the rental income figure for both front and back end ratios. As for splitting the income, you should be able to split the positive cash flow. It may be a little more complicated than that though because you have repairs and miscellaneous expenses that go along with a rental, so the $100 a month you are getting now might turn into nothing or a negative cash flow when you have to perform repairs, etcYou should probably look at what you declared as the net rental income on your tax returns or financial statements for the last couple years. I am presuming you offset rental income by renal expenses, so your net rental income might not be anything at all or negligible. If you want to make it simple though you can just put the $50 positive rental income thats coming in now and disclose it on your financial worksheet.

Question number 3: For the Front DTI, I do not include HOEL. Correct?

Answer: The Obama plan words that a little strangely, but yes. Front end looks at the first lien position, back end includes all debt obligations including subordinate mortgage liens.

Question number 4: To calculate Back DTI what expenses do I include besides HOEL, second mortgages, credit cards, car loans, other loans?

Answer: The regulations that came out on March 4, 2009, list the following obligations as needing to be included in the Back-end DTI (debt-to-income) calculation: All Front-end PITIA plus any mortgage insurance premiums, payments on all installment debts, monthly payments on all junior liens, alimony, car lease payments, aggregate negative net rental income, monthly mortgage payments on second homes.

Question number 5: Do I need to include car insurance, utilities, etc.

Answer: No. The DTI looks at your payment obligations on installment debts. Your overall financial budget should consider these items, but for the DTI calculations no. All items included in the DTI calculations will need to be verified, or what you may have heard called full documentation.

Question number 6: When calculating Back DTI do I only use the minimum amount for the HOEL which is only for the interest amount?

Answer: You should include the amount you are obligated to pay each month to avoid defaulting. If the payment calls for $100 per month and is an interest only payment, you should put down $100. If you pay more each month toward principal but are not obligated under the terms of the note to do so, you shouldnt include that amount. The same goes for credit card balances. If you only have to pay $18/month but pay $150 because you want to pay down the balance and avoid some finance charges, the amount you include for the obligation calculation is $18.

Question number 7: Is a rental property considered a liquid asset?

Answer: Only after you sell it and turn it into cash. Its real property. It should have been on the schedule of real estate owned on your loan application if you owned it at the time you applied for the loan on the primary. Liquid assets are items like cash, money in checking or savings accounts, money market accounts, stocks/bonds/cds and the like. Basically cash or cash substitutes, not a rental house.