Real Estate Exam [National] 84, Loan Qualification DTI Explained

0:00Understanding the mechanics of debt-to-income ratios and loan qualification is essential for the national portion of the real estate exam. Lenders evaluate a borrower's ability to pay as a central part of the finance section of your test. Let's start with the two primary ratios you must master, which are the front-end ratio and the back-end ratio. The front-end ratio focuses specifically on the housing expense. In exam questions, this is often referred to as PITI, which stands for Principle, Interest, Taxes, and Insurance. To calculate this ratio, you take the total monthly housing expense and divide it by the borrower's gross monthly income. This is a common trap on the exam, because questions will often provide you with a borrower's net income or take-home pay. But lenders always use gross monthly income before taxes are deducted. If you see both numbers in a word problem, always select the gross income for your calculation. If the question gives you an annual salary,

1:01you must remember to divide it by 12 before starting your ratio math. The back-end ratio is more comprehensive and is often the one that determines if a loan will actually be approved. This ratio takes that same housing expense and adds all other recurring monthly debts. These include car payments, student loans, credit card minimum payments, alimony and child support. One key thing to remember for the exam is that things like utilities or groceries are not included in the back-end ratio because they are not contractual debts. You divide this total debt amount by the gross monthly income to find the percentage. A favorite trick on the exam is to include a borrower's monthly cable bill or gin membership in the list of expenses. You must ignore these because they are not considered long-term debt obligations. When it is time to apply these concepts to conventional loans, you need to memorize the standard guidelines of 28% for the front-end and 36% for the back-end.

2:03This means a borrower's house payment should not exceed 28% of their gross income and their total debt should not exceed 36%. However, if you see a question specifically mentioning an FHA loan, the numbers change to 31% for the front-end and 43% for the back-end. FHA loans allow for a higher debt load, which makes them more accessible for many first-time buyers. These specific percentages are high priority items to memorize because the exam might ask you to identify the specific ratio without providing the numbers. The exam will frequently test you with a scenario where you have to determine the maximum loan amount a borrower can afford based on these ratios. To solve these, you should calculate the maximum payment allowed under both the front-end and the back-end limits and then choose the lower of the two numbers. Lenders will always qualify a borrower based on the more conservative figure. For example, if the front-end allows a $2,000 payment

3:05but the back-end only allows 1,800 due to a large car payment, the answer is 1,800 dollars. A major confusion point is what qualifies as debt. For the back-end ratio, look for fixed long-term obligations. To help you remember the difference between the two ratios, use the phrase front for the house and back for the bank. The front-end is strictly the house cost while the back-end includes everything you owe to any bank or creditor. Beyond just the ratios, lenders also evaluate the three C's, which are capacity, capital, and character. Capacity is the income and debt to income ratios we just discussed. Capital refers to the assets or cash reserves the borrower has for a down payment and closing costs. Character is represented by the credit score and history. On the exam, expect questions that combine these elements, such as asking if a borrower with a perfect credit score but a 50% back-end ratio would qualify for a conventional loan.

4:08The answer would be no because they fail the debt ratio requirement, regardless of their credit score. Stay focused on using gross monthly income and always double-check if the question asks for the front-end or back-end limit before you start your math. This is a quantitative section of the exam, so take your time with the calculator and ensure you are not accidentally using annual figures or net income totals.