Lenders use debt-to-income (DTI) ratios to determine whether a borrower can afford a mortgage. There are two ratios used in underwriting:
Housing Ratio (Front-End DTI): Monthly housing expense divided by gross monthly income. The housing expense includes PITI — Principal, Interest, Taxes, and Insurance — plus any HOA dues or mortgage insurance. Conventional lenders typically want this at or below 28%; FHA allows up to 31%.
Total Debt Ratio (Back-End DTI): All monthly debt payments (housing + car payments + student loans + credit card minimums + any other installment or revolving debt) divided by gross monthly income. Conventional guidelines are typically 36–43%; FHA allows up to 43% (or higher with compensating factors).
Example Calculation:
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PITI is the standard way to express the full monthly housing cost:
For condos or planned developments, HOA dues may also be included in the qualifying payment. PMI (private mortgage insurance) is added when LTV exceeds 80%.
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Lenders look for stable, documentable income. Key rules:
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LTV = Loan Amount ÷ Appraised Value (or Purchase Price, whichever is lower)
Example: $480,000 loan on a $600,000 home = 80% LTV.
Combined LTV (CLTV) includes all liens (first + second mortgage + HELOC) divided by value.
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PMI protects the lender (not the borrower) if the borrower defaults. Required on conventional loans when LTV > 80%. PMI can be:
Typical PMI costs: 0.2%–1.5% of the loan amount per year depending on credit score and LTV.
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Credit scores (FICO) directly affect the interest rate and loan eligibility:
| FICO Score | Conventional | FHA | |---|---|---| | 760+ | Best rates | Eligible | | 700–759 | Good rates | Eligible | | 640–699 | Higher rate/PMI | Eligible | | 580–639 | Limited programs | 3.5% down eligible | | <580 | Very limited | 10% down required |
A difference of 60–80 FICO points can mean a rate change of 0.5–1.0%, costing a California borrower tens of thousands of dollars over the loan term.
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The TRID rule (effective 2015) merged several older disclosure forms into two key documents:
Loan Estimate (LE): Provided to the borrower within 3 business days of a completed loan application. Contains estimated loan terms, projected monthly payment, and closing costs. The application is considered complete once the lender has the borrower's name, income, SSN, property address, estimated value, and desired loan amount.
Closing Disclosure (CD): Provided to the borrower at least 3 business days before closing. Contains the final loan terms and actual closing costs. If certain changes occur (APR increases by more than 1/8%, loan product changes, prepayment penalty added), a new 3-day waiting period is triggered.
TRID violations can delay closings — agents must understand these timelines to manage client expectations in CA transactions.
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Quiz Questions:
Q1. A borrower has a gross monthly income of $8,000. Their proposed PITI payment is $2,200. They also have a $400 car payment and $200 in student loan payments. What is their back-end DTI ratio?
A) 27.5% B) 35% C) 28% D) 30%
Answer: B — Back-end DTI = all debts ÷ gross income. ($2,200 + $400 + $200) = $2,800 ÷ $8,000 = 35%. The front-end ratio is $2,200 ÷ $8,000 = 27.5%.
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Q2. A buyer purchases a home for $700,000 and makes a $105,000 down payment. The loan amount is $595,000. What is the LTV ratio and will PMI be required on a conventional loan?
A) 85% LTV; PMI required B) 80% LTV; PMI not required C) 85% LTV; PMI not required D) 15% LTV; PMI required
Answer: A — LTV = $595,000 ÷ $700,000 = 85%. Since LTV exceeds 80%, PMI is required on a conventional loan. The down payment is 15%, not 20%, so the 80% threshold is not met.
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Q3. Under TRID, when must the lender deliver the Closing Disclosure to the borrower?
A) At least 1 business day before closing B) At least 3 business days before closing C) At least 5 business days before closing D) At closing
Answer: B — TRID requires the Closing Disclosure be delivered at least 3 business days before the loan closes. This gives the borrower time to review final numbers and compare to the Loan Estimate. Violations can delay closing.
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Q4. A self-employed borrower shows $120,000 in net income on Year 1 tax returns and $100,000 in Year 2. How will most lenders calculate qualifying income?
A) $120,000 (use the higher year) B) $110,000 (2-year average) C) $100,000 (use the lower declining year) D) $130,000 (gross receipts before deductions)
Answer: C — When self-employed income is declining year-over-year, lenders typically use the lower year's income rather than the average to be conservative. If income were stable or increasing, the 2-year average would be used.
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Q5. Which of the following is TRUE about PMI on a conventional loan?
A) PMI protects the borrower if property values decline B) PMI is required if the LTV ratio exceeds 80% C) PMI cannot be cancelled once it is established D) PMI is required on all FHA loans regardless of LTV
Answer: B — PMI is required on conventional loans when LTV exceeds 80%. It protects the lender, not the borrower. Under the Homeowners Protection Act, borrowers can request cancellation when LTV reaches 80%, and it must be automatically cancelled at 78% LTV. FHA loans have MIP (not PMI), which has different cancellation rules.