When you apply for a mortgage, you have many choices. The main options include: conventional, FHA, USDA, and VA loans. There are also subprime options, but those guidelines vary by lender. There are not universal loan parameters for these programs. The main programs all have basic DTI requirements you must abide by in order to qualify.
DTI stands for debt-to-income ratio. It measures the amount of your monthly income that goes towards your monthly expenses. There is a front-end ratio that shows how much of your money goes towards your housing payment each month. There is also a back-end ratio that shows how much of your money goes towards all of your monthly expenses, including the new mortgage payment.
Understand the ratios will help you determine which program you may or may not qualify for when applying for a mortgage.
Conventional loans have the strictest guidelines. They require the highest credit scores and the lowest debt ratios. On the front-end, they require a 28% maximum debt ratio. For example, let’s say you make $60,000 per year. Your new mortgage payment including principal, interest, taxes, and insurance could not be more than $1,166:
$50,000/12 months = $4,167
$4,167 x .28 = $1,166
Again, this includes everything that you would pay for your home, whether or not you escrow your real estate taxes and homeowner’s insurance. You would have to include the principal and interest payment, plus 1/12th of your annual real estate taxes and homeowner’s insurance. If you pay Private Mortgage Insurance because you put less than 20% down on the home, you must include that as well.
On the back-end, conventional loans require a maximum debt ratio of 36%. This includes the total mortgage payment PLUS any other monthly obligations you have. This does not include, however, the cost of daily living or utility expenses. The lender will include expenses, such as:
- Minimum credit card payments
- Student loan payments
- Car loan payments
- Installment loan payments
- Personal loan payments
- Payment agreement for any past due taxes or collections
The total of these payments and your new mortgage payment should not exceed 36% of your monthly income. Keep in mind, lenders use your ‘gross monthly income.’ This means the money you make before taxes. In our above example, your total monthly payments could not exceed $1,500:
$4,167 x .36 = $1,500
FHA loans have slightly more relaxed guidelines than conventional loans. You can have higher debt ratios as their maximums are 31% on the front-end and 43% on the back. This gives you a little more wiggle room as far as a larger mortgage payment and/or more monthly expenses.
Using our above example of $4,167 gross monthly income, you could qualify for:
$4,167 x .31 = $1,291 mortgage payment rather than $1,116 for a conventional loan
$4,167 x .43 = $1,792 total monthly payments rather than $1,500
FHA loans also require only 3.5% down on the home. Potentially, you may qualify for a larger mortgage with the FHA program because of the higher DTI allowances.
USDA loans are reserved for low-income borrowers living in a rural area. This no money down mortgage program also has relaxed DTI ratio requirements, though. The program allows a 29% front-end debt ratio and 41% back-end debt ratio. This is slightly stricter than the FHA guidelines, but this program is for low-income families. They want to keep the mortgage payment and your monthly debts affordable.
The USDA looks at household income a little differently though. They base your eligibility for the program on your total household income. If it exceeds 115% of the median income for the area, you are not eligible for the program. Total household income includes any adult making an income in your home, not just the borrowers on the loan. However, they do not use this income for qualifying purposes. You must qualify with the above DTI ratios using only the income from the borrower and co-borrower. Other household income could serve as a compensating factor, though.
VA loans are unique among all of the programs. Technically, the VA does not require a specific DTI. They do recommend that borrowers do not have more than 43% of their monthly income taken up by all of their monthly debts. However, they don’t specify a front-end ratio.
The VA focuses on your monthly disposable income more than anything else. This is how they determine how much you can afford. They require a specific amount of disposable income each month based on your location and family size. As long as you have the required amount left over, they feel that you are not a high risk because your disposable income can take care of your daily living expenses.
However, you will likely find that various lenders have specific DTI ratio requirements. The lenders fund the loans, so they are the ones taking the risk. Even though the VA backs them up and pays the lender a portion of any funds they lose in foreclosure, the lender still takes a risk. It pays to ask each lender what debt ratio requirements they have.
As you can see, each program has distinct requirements. Shopping around and getting quotes for each program you are eligible for can help you determine the right program for your family. Minimizing your debts and therefore making your DTI more attractive will help you be eligible for more loan programs.