Conventional Loan Debt to Income Ratio

Did you know that the debt to income ratio determines how much you can borrow?

Debt to income balance scaleThe debt to income ratios are a common metric for determining the eligibility of a borrower for a conventional loan. A debt-to-income ratio is a representation of how much of your monthly budget goes toward the payment of your debts.

When you apply for a mortgage, lenders look at your DTI ratios to determine if you can keep up with payments. As a general rule, the lower your DTI ratio, you’ll be a better candidate for a loan.

What Is the Debt-to-Income (DTI) Ratio?

The abbreviation "DTI" stands for "debt to income. " It is the proportion of total debt to total income that a person carries at any given point in time. There are two debt to income ratios. The front end ratio which looks at the monthly payment and the back end ratio which takes into consideration the anticipated mortgage payment and monthly bills.

The DTI is a great tool to use when comparing loan programs with different down payment and closing costs. When you are deciding whether or not you want to take out a mortgage, it is always best to compare the debt-to income

What is a Front End Debt to Income Ratio?

The front-end ratio is used to determine the maximum mortgage payment that a borrower may make. The front-end ratio is also referred to as the payment ratio. To determine front end ratio, divide your monthly mortgage payment by your gross monthly income.

This estimate includes principal and interest, real estate taxes, homeowner's insurance, homeowner's association dues, mandatory maintenance fees, common charges within a development, private mortgage insurance, and maybe flood insurance.

The highest payment ratio is set by the loan program. If the borrower's front-end debt ratio exceeds the loan program's maximum, the borrower must lower the loan amount. Multiply your gross monthly income by 33% to estimate your mortgage payment.

How To Calculate Your Front End Debt-To-Income Ratio (DTI)

To calculate the front end ratio, divide the anticipated monthly mortgage payment by the gross monthly income to arrive at the Front Ratio. This calculation takes into account principle and interest, real estate taxes, and homeowner's insurance, as well as homeowner's association dues, required maintenance fees, common charges within a development, and, if applicable, private mortgage insurance, and possibly flood insurance. Here's an example of the front end payment ratio:
Monthly gross revenue = $6,000
Mortgage payment estimate = $1,500
Ratio of the Front End-$1,500/$6,000 = 25%

What is the Back End Debt to Income Ratio?

The Back Ratio is similar to the front end ratio except that it includes the monthly loan payment, and monthly debt payments. Consumer debt obligations include, but are not limited to, credit card payments, car payments, and school or personal loans. Alimony and child support payments are also included in the back end ratio calculation.

Insurance premiums for life, health, and child care are all examples of items that are often omitted from a back-end ratio.

How To Calculate Your Back End Debt-To-Income Ratio (DTI)

Here's an example of the back end ratio calculation:

To calculate your DTI, divide your total monthly income by your recurring monthly debt.

Proposed mortgage payment - $1,500 (includes taxes, insurance, PMI, if required)
Car loan - $100
Credit cards payments -  $400.
TOTAL MONTHLY PAYMENTS = $2,000.

The monthly gross income is $6,000.00.
Debt-to-income ratio = $2,000/$6,000 = 33%

Most lenders look at your back end DTI because it gives them a more complete picture of how much you spend each month. Back-end DTI provides lenders a more thorough view of your monthly spending.

Debt-to-Income Requirements Vary by the Type of Loan

Debt to income requirements vary depending on the type of loan.

FHA Home Loans

FHA logoMortgages insured by the Federal Housing Administration are known as FHA loans. FHA loans have looser credit score requirements. FHA loans have a maximum DTI of 57 percent, although the actual number is chosen on an individual basis.
Read more about FHA mortgages at FHA Loan Plus

USDA Mortgages

USDA logoUSDA loans can only be used for rural property purchases or refinancing. To be eligible for a USDA loan, your debt-to-income ratio must be below 41%.

USDA loans include a few of specific requirements. To begin, in order to qualify for a loan from the USDA, your annual household income cannot be more than 115 percent of the local median income.
Your lender must consider the combined income of all family members when calculating your eligibility for a USDA loan. This means they must check the income of all residents, whether or not they're on the mortgage.

Your lender will only examine the income and responsibilities of those on the loan when determining your debt-to-income ratio (DTI). If there are other persons living in the residence, only their combined salaries will be considered. It won't affect DTI.
Read more about USDA mortgages at USDA Loan Plus

Veteran Mortgage (VA Loan)

VA mortgage logoCurrent and former members of the military can purchase a house at a reduced cost thanks to VA financing. VA loans offer forgiving debt-to-income ratios and do not need a down payment. In exceptional instances, a DTI of 60% may qualify you for a VA loan. The Veteran's Administration employs the residual income calculation in addition to the standard debt-to-income ratio.
Read more about VA mortgages at VA Loan Plus.

Conventional Mortgage (a.k.a conforming loan)

Conventional loan graphicThe DTI criteria for conventional loans varies depending on your personal circumstances and the credit you want. A DTI of 50% or less is frequently necessary for a conventional loan. In rare cases, a DTI of up to 65% may be acceptable.

How Can I Lower My Debt-To-Income Ratio?

Prior to making a mortgage application, there are steps you may do to reduce your DTI, or debt-to-income ratio.

Pay off your smallest monthly debt obligations debts first, but don't pay them off.

Eliminating your monthly payments is the easiest way to lower your DTI. If possible, you should prioritize paying down the smaller payments first, but you should not pay off these accounts.

According to Experian:

Reduce balances on revolving accounts. Your credit utilization is calculated by taking the total of all your credit card balances and dividing it by the total of all your credit card limits. The lower your credit utilization rate, the better. Credit utilization ratio above 30% can start to bring down your scores, and people with the best credit scores tend to keep their credit utilization below 10%. If possible, you should aim to pay your credit card balances off in full each month.
The Experian site has a wealth of information on improving your credit.

Pay Down Installment Debt to 10 Payments or Less

Lenders are permitted by Fannie Mae and Freddie Mac to omit consumer installment debt that has 10 payments or less. Nevertheless, lenders and underwriters have the last decision about whether they would disregard the debt payment.

Increase Your Earnings

You can lower your DTI by increasing the amount of money you bring in through freelancing, working additional hours at your existing job, or starting a side business. Bear in mind, however, that you will need to be able to demonstrate that the income you are now getting is consistent and will continue in the foreseeable future. In general, lenders like to see a history of at least two years for each source of income.

Consider Obtaining a Cosigner for Your Mortgage

If you are buying a home with a partner or spouse, your mortgage lender will use both of your incomes and debts to calculate your debt to income ratio. Adding your partner to your loan can lower your total household debt. Adding them to the loan may not help your situation if your partner's DTI is higher than yours. If that's the case, you can always ask a family member or close friend to cosign the mortgage loan with you. If you use a co signer, you may be able to qualify for a larger mortgage or lower interest rates.

Increase Your Down Payment

By increasing your down payment, you are lowering your mortgage payment and thereby reducing your debt to income ratio. Sounds simple, I know, but if you can obtain a monetary gift, that money could be used to reduce your loan balances.

Rotating Question markFAQs About Debt to Income Ratios

The debt to income ratio impacts the loan size and interest rate when buying a home. This ratio is more than meets the eye. Check the commonly asked questions to prepare for the application process.

Is all debt treated the same in my debt-to-income ratio?

Your ability to get a mortgage will depend on how much of your income you spend. The type of debt has nothing to do with the amount of debt. It will be harder for you to get a loan if you have a lot of debt. Payments for credit card debt, auto loans, and student loans are all handled the same way. The minimum payment on each account is all that matters to the lender.

How quickly can I improve my DTI?

You can quickly raise your DTI by paying off your debt, since your ratio is based on how much debt you have at any given time. This is because your DTI depends on how much debt you have in total. Your ratio will get better and your mortgage application will look better in direct proportion to how quickly you pay off your debt. You can make more money in a number of ways, and getting a job is one of them.

Rapid Rescore

It might take some time for the credit bureaus to rescore your account. There could be a mistake on your credit report that is making your credit score go down. Or maybe you just paid off a few accounts, but your credit report isn't up to date.

So how do you clear up your credit report? Request that your lender use Rapid Rescore. How does it work? You will show the lender proof that your account has been paid or changed.

The lender will send your paperwork to one or more credit agencies so that your credit report and credit score can be reevaluated and changed. Improving your credit score lowers your interest rate, mortgage payment, and debt-to-income ratio.

Paying down debt, but not too much

If you pay off your obligations in full, your credit score may drop. The credit scoring system is designed to look at all open accounts. Pay your accounts down, to 30% of the credit limit. Don't payoff your bills.
See Experian above.

Should I apply for a mortgage that has a high DTI (debt-to-income ratio)?
If you have a high debt-to-income ratio, some lenders may not provide you a home loan or charge you a higher interest rate. But only in particular situations. You can still acquire a mortgage loan with a high DTI, but it's in your best interest to minimize it if possible to get a better interest rate.

Does the debt-to-income ratio affect your credit?

Debt-to-income ratio doesn't effect credit score. It tells you how much of your monthly income should go toward recurrent debt. If you pay the legal minimums on time each month, a high DTI does not automatically mean a low credit score. But it increases the chance.

SOURCE: Debt-to-income Ratios

Conclusion

In conclusion, your debt to income ratio is a major factor in your ability to buy a home. Lenders look at this ratio to see how much debt you can afford to take on in addition to your new mortgage. A high debt to income ratio means you are a higher risk borrower, and may not be able to get a loan at all. Try to keep your debt to income ratio as low as possible before buying a home.

Recommended Reading

  1. How to Calculate the Mortgage Loan-to-Value Ratio (LTV) 
  2. How to Get a Mortgage With a Non-occupant Co-borrower 
  3. How to Lower Your Interest Rate With a 2-1 Buydown Mortgage