Debt to Income (DTI) Ratio Guidelines for Mortgage Approval
This article covers the debt-to-income ratio (DTI) and how it affects mortgage approval
When you apply for a home loan, lenders want to know that you are both willing and able to make your payments as agreed. Your credit score indicates your willingness to repay your loan because it shows who you have handled debt in the past. Your DTI indicates your ability to repay because it shows the relationship between your income and your expenses.
What Is Your Debt-to-Income Ratio (DTI)?
Your DTI is the relationship between the amount of income you have and the amount you spend on your monthly bills. It’s a way for mortgage underwriters to see if you can afford to repay your mortgage when you apply for a home loan.
You calculate your DTI like this:
- Add up all sources of monthly income. Use the gross (before tax) income.
- Add up your regular bills like auto loan payments, minimum payments for your credit card accounts, student loan payments, plus your total housing cost. Housing cost is your rent or your mortgage including principal, interest, property taxes and homeowners insurance.
- Divide your total expenses by your gross income.
Note that you don’t include living expenses like food, child care and utilities in the DTI. Just accounts requiring regular payments plus your housing cost.
What’s a Good DTI for Mortgage Approval?
Mortgage lenders like to see a low debt-to-income ratio — the lower, the better. But the maximum acceptable DTI depends on many factors. If your application is otherwise very strong, with a high credit score and a large down payment, you can easily get a loan with a high DTI.
For example, Fannie Mae’s guidelines will approve highly-qualified applicants with a DTI as high as 50%. But less-qualified applicants who go through manual underwriting may be limited to 36%.
Government-backed mortgage guidelines are more generous:
- FHA allows a maximum of 57% DTI for highly-qualified applicants.
- USDA limits the debt-to-income to 41%. However, USDA also offers longer repayment terms to reduce monthly mortgage payments and subsidized interest rates for low-income applicants.
- The VA does not limit DTI but applicants over 41% may have to work harder to prove they can afford their payment. In addition, the VA allows a more generous alternative calculation called residual income.
If you can’t qualify for a mortgage with a conventional (non-government) loan program, try applying for a government-backed mortgage.
High DTI: Just because You Can Doesn’t Mean You Should
Understand that even if you qualify based on program guidelines, you might find a program unaffordable if your living expenses like food, healthcare, or commuting costs are especially high. That’s because lenders don’t consider these costs when underwriting your application. It’s up to you to make sure a payment feels affordable to you based on your spending habits.
One thing you can do to lower your risk is to save money for emergencies. Lenders call these savings reserves. If your income drops or you have unexpected expenses, you can use reserves to make your mortgage payment. Lenders measure reserves in months — the number of mortgage payments you can make with your savings.
If your mortgage payment is $1,000 per month, and you’ll have $3,000 in the bank after closing on your home loan, you have three months of reserves.
Different Lenders, Different Guidelines
The guidelines listed above are pretty generous. However, most lenders won’t actually approve applicants with those higher numbers. That’s because most lenders impose lender overlays. An overlay is simply a requirement that is not part of the guidelines for a program.
For example, the FHA allows lenders to approve borrowers with credit scores as low as 580 with 3.5% down. But many lenders set that minimum score at 620. That’s an overlay.
If you’re concerned about mortgage approval with higher debt-to-income ratios, your best bet is to prequalify online with Gustan Cho Associates. If your application gets an approval from our automated underwriting system (AUS), you should be able to close your loan and complete your purchase or refinance.
With VA Loans, debt to income ratios depends on recommendations from automated underwriting systems (AUS). Automated systems weigh a number of factors including the size of your down payment, your credit score, emergency savings (called reserves), and debt-to-income ratios.
Normally, you need to offset weakness in one area (such as credit score) with strength in other areas (for instance, make a higher down payment or save up some cash reserves). Most lenders set their maximum DTI at 41% to 50%.
The Department of Veterans Affairs has established no maximum DTI or minimum credit score. But most lenders do set some limits. Lender guidelines that are stricter than required by the official program are called “overlays.” Most lenders have overlays for VA home loans. Gustan Cho Associates has no overlays.
DTI for FHA Loans With Credit Scores Under 620
Homebuyers or homeowners can qualify for an FHA Loan with 580 credit scores and 3.5% down. If credit scores are under 620, however, the maximum debt to income ratio is 43% with Automated Underwriting System Approval.
Borrowers with credit scores are at least 620 can have DTI as high as 56.9% if they get an AUS approve/eligible recommendation. If your credit scores are close to 620, you might want to work on raising them to take advantage of higher DTI caps.
You might be able to do this by paying down credit card balances, asking a friend or relative with excellent credit to add you as an authorized user on their accounts. Their good credit will then be included on your credit report and your credit scores.
You can also up your score by paying off your credit cards with a personal loan. That drops your utilization ratio, which comprises 30% of your score, to zero. You can instantly improve your credit with this strategy.
How a Good Lender Can Help You Qualify With a High DTI
Applicants with high DTI numbers can have their mortgage approval snatched away at the last minute if they aren’t super careful.
- If the property taxes for a new home are higher than expected, you can lose your approval.
- If your expenses go up; for instance, if you increase your credit card balances, you can lose your loan.
- A good loan officer can help you creatively rearrange your finances to lower your DTI, or help you buy your rate down to reduce your mortgage payment and DTI.
Gustan Cho Associates has no overlays on government and conventional loans. Borrowers who need to qualify for a mortgage with a mortgage company licensed in multiple states with no lender overlays, please contact us at Gustan Cho Associates at 262-716-8151 or text us for a faster response. Or email us at [email protected] The team at Gustan Cho Associates is available 7 days a week, evenings, weekends, and holidays.