How Your Debt to Income Ratio Can Affect Your Mortgage

There are many factors that lenders evaluate when considering you for a mortgage. One of the most importatnt is your debt-to-income ratio, which indicates how much of your income your monthly debt takes up.

Calculating your DTI is fairly easy and is a good way to gauge what mortgage loans you might be eligible for when buyin or refinancing a home.

What is a debt-to-income ratio?

A debt-to-income ratio (DTI) is expressed as a percentage, showing how much of your total monthly income goes toward debt payments each month. This includes your house payment, credit cards, other loans, and more. It's calculated like this:

(Total monthly debt) / (Gross monthly income) x 100 = DTI

Technically, there are two types of DTI ratios that lenders look at when considering a mortgage application:

  • Front-end DTI: This includes just your housing related debts (what your expected new mortgage payment, taxes, insurance, etc. would be) compated to your monthly income.
  • Back-end DTI: This is used more widely by lenders because it takes into account all your debts.

For example, if the mortgage you're applying for would cost $1,200 per month, and you also have a $500 student loan payment, and a monthly income of $6,000, then your front-end DTI would be 20% (1,200 / 6,000 x 100).

Your back-end DTI, on the other hand, would be 28.3% (1,700 / 6,000 x 100). Generally, the back-end DTI is the most important consideration for a lender, as it more accurately reflects how comfortable you can afford your new mortgage each month.

What DTI ratio do you need for a mortgage?

DTI requirements vary by loan type, so the threshold you'll need to fall under will depend on what type of mortgage you choose. Here's a quick look at what the general, minimum DTI requirements look lke by loan type:

FHA Loans

FHA loans tend to have looser qualifying requirements than other loan types. On these mortgages, you can have a back-end DTI as high as 43% and still qualify, or even higher if there are compensating factors. If you're applying for an FHA Energy Efficient Homes (EEH) mortgage, the DTI maximum goes up to 45%.

Your front-end DTI must be 31% or less (33% for EEH loans) without compensating factors. According to the Consumer Financial Protection Bureau, the median DTI of FHA borrowers is 44%.

USDA Loans

On USDA loans, also sometimes called rural housing loans, the DTI requirements are 29% on the front-end and 41% on the back-end. The CFPB shows that 36% is the median DTI for USDA borrowers.

VA Loans

The VA technically sets a maximum back-end DTI or 41%, but because military members often receive a lot of tax-free income that isn't calculated into these ratios, lenders are free to go beyond the 41% threshold with no limits. In fact, according to the CFPB, the median DTI for VA borrowers is 42%.

Conventional Loans

On conventional loans, the maximum back-end DTI is 50%. There are tigher restrictions for DTI on "manual underwrites," including a 36% to 45% cap on back-end DTI depending on your credit score and the amount of cash you have for reserves. The CFPB shows the median DTI of conventional borrowers is 37%.

Tips for improving you debt-to-income ratio

If your current DTI doesn't qualify you for a mortgage, there are steps you can take to improve your ratio:

1. Pay down or pay off your debt: The lower your monthly debt payments are, the lower your DTI will be, which will improve your chances of qualifying for a loan.

2. Increase your income: Raising your income by even just a little bit each month can also help reduce your DTI. Consider taking on a side gig or asking for a raise to bump your pay up a bit.

3. Add a co-borrower: Having another person, such as a family member, spouse, partner, or other trusted friend apply for the loan with you can also help. Instead of just looking at your income the lender might take into account both of your salaries. This could lower your DTI and boost your chances of qualifying.

Improving your DTI can also qualify you for better terms and interest rates, so even if your DTI is under the max threshold, you might consider working on your ratio before applying for your loan. If it's your first home you're buying, you can also save with these programs for first-time homebuyers.

Works Cited:

Yale, Aly J. “How Your Debt to Income Ratio Can Affect Your Mortgage.” Credible, Credible, 2 July 2020, www.credible.com/blog/mortgages/dti-for-mortgage/.

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