You think you can afford a mortgage, right? You head into the lender and fill out an application. A few hours later you learn that you cannot afford what you thought. What made the difference? Chances are it was your DTI or debt-to-income ratio. This little number has a large bearing on whether you can get financing or not. The good news is, you have some control over your ratio. The bad news is you may have some work ahead of you if you have to lower your debts.
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If you use FHA financing, you may see less stringent guidelines. Just like with credit scores, the FHA does not have high expectations regarding the debt ratio. That doesn’t mean you can go run up your credit cards and still get approved. It does mean you have some leeway though. Read on to learn more about how your debt ratios may affect your chances of FHA approval.
Calculate your Debt Ratio
First, let’s look at your debt ratio as the lender does. It might look different to you because certain things are not included. The lender only counts those bills that report to the credit bureaus. Think of bill, such as:
- Credit cards
- Car payments
- Student loans
- Personal loans
- Mortgages
These bills report to the credit bureaus. This means Experian, TransUnion, and Equifax report how often you make your payments on time. Lenders can see how many 30-day late payments (or more) you have or how much of your available credit on your credit card you used. While these factors are important, what they focus on for your debt ratio is the monthly payments.
For the most part, the payments are reported on the credit report. Car payments and personal loans are good examples. Lenders only use your minimum required payment for your credit card for the DTI, though. This means if you have $1,000 borrowed, but your minimum payment is $49, the lender uses $49 to calculate your DTI.
Calculating your debt ratio can get tricky if you have any of the following debts:
- Deferred student loans – Even if you don’t owe money on your student loans yet, you must still include a payment in your debt ratio. Your payments are not going to be deferred forever, so the lender needs to include the payment now to make sure you can afford the new mortgage. Most lenders use 2% of the outstanding balance as a minimum payment if you cannot prove a lower payment otherwise.
- Car payments with less than 10 payments left – Lenders can exclude the portion of your monthly payment that is less than 5% of your monthly income. For example, let’s say you make $5,000 per month. 5% of that amount is $250. You must then include any installment payments that have less than 10 payments left that exceed $250 in your ratio. Let’s say your car payment is $400, the lender would include $150 of that car payment in your debt ratio.
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Ratios the FHA Allows
Now that you know how to calculate the debt ratio like a lender would, you need to know what the FHA allows. This has a two-part answer. The FHA themselves allow ratios of 31/43. This means 31% of your gross monthly income can cover your monthly mortgage payment. This includes principal, interest, taxes, and insurance. It also means 43% of your gross monthly income can cover your total monthly debts – these are the amounts we talked about above plus the mortgage payment.
However, the funding lender has the final say in the debt ratio. You may find a lender that is not willing to accept ratios as high as 31/43. They may only allow 28/36, which is the conventional loan debt ratio maximum. It depends on the lender and their threshold for risk. Your other qualifying factors also play a role, as we will discuss below.
Getting Around a High Debt Ratio
So what if you have a 32/44 debt ratio? Would you be ineligible? With some lenders, you might not be able to qualify. Some, however, may look at your compensating factors. These are positive factors on your loan application that go above and beyond the required factors. Here’s a sample of some compensating factors:
- Reserves on hand – Any liquid assets you have on hand that can cover your monthly mortgage payment is a benefit. The lender counts your reserve based on the number of months it can pay your mortgage. For example, if your mortgage payment is $1,000 and you have $4,000 in a savings account, you have 4 months of reserves.
- High credit scores – The FHA is known for their lenient credit score guidelines. However, a higher credit score can work in your favor. It shows that you are financially responsible and are a good credit risk.
- Stable employment – No lender likes to see an application that hops from job to job. They want stability. The longer you are at the same job, the lower risk you pose to the lender.
These are just a sampling of the compensating factors your lender may accept. Always give your lender all of the information pertaining to your situation. Don’t’ hold anything back because you never know when one factor may help you offset a risk on your application.
Keep in mind, because FHA lenders have their own say, every lender may have a different opinion on the maximum DTI for an FHA loan. If you have a unique circumstance and know your ratios are on the higher end, shop around. You never know when you will find a lender willing to accept your situation. Don’t assume your ratios are too high, either. Work on your compensating factors and then work with your lender to see if you qualify.
FHA financing offers the advantage of flexibility as well as the government-guarantee. This oftentimes means lenders will take on situations they would not take without the guarantee. The bottom line is, you never know until you apply!
