How Underwriters Calculate Debt-to-Income Ratio (DTI) – 2024 Guide
When it comes to buying a home, there are a few numbers that can make or break your mortgage application. One of the biggest? Your debt-to-income ratio (DTI). Understanding how underwriters calculate DTI can help you better prepare for mortgage approval, increase your chances of getting approved, and, ultimately, help you get the best terms on your loan. Let’s dive into everything you need to know about how DTI works in 2024!
Understanding Debt-to-Income Ratio (DTI)
What is DTI?
Dale Elenteny of Gustan Cho Associates best explains the definition of debt-to-income ratio used by mortgage lenders:
Your DTI ratio is a simple calculation: the sum of your monthly liabilities divided by your total monthly earnings (the income you receive before taxes). Lenders see this as a gauge of how much of your income goes toward paying off debts and how much room you have for a mortgage payment. Speak With Our Loan Officer for Mortgage Loans
Why It Matters for Mortgage Approval
Lenders use your DTI ratio to understand your financial health. A low DTI ratio suggests you can manage your debts comfortably and are less likely to default on your loan, making you a safer bet for mortgage lenders. In contrast, a higher DTI can signal that a borrower might struggle with new debt. Most lenders prefer a DTI under 50% for conventional loans, with different limits for various loan types.
Types of DTI
There are two main types of DTI that underwriters consider:
- Front-End DTI: This represents the portion of your earnings dedicated solely to housing costs (including your new mortgage payment, property taxes, and homeowners insurance).
- Back-End DTI: This considers all monthly debts, including housing expenses, credit card payments, car loans, student loans, and other recurring debt obligations.
Why Mortgage Underwriters Focus on DTI
Risk Factor
Underwriters want to ensure you can comfortably afford your mortgage payments without financial stress. The lower your DTI, the better your financial standing appears to lenders.
Borrower Insights
Here’s a big takeaway: a low DTI can mean better loan terms, like lower interest rates. In short, a manageable DTI makes you a more attractive borrower, which can sometimes even expedite the approval process.
How Underwriters Calculate DTI
Let’s break down how underwriters calculate DTI. It’s straightforward, but understanding the components can be powerful.
Monthly Obligations Included
Underwriters add up all your recurring monthly debts. Here’s a typical breakdown:
- Credit Cards: The minimum monthly payment required on your credit cards.
- Student Loans: Monthly payments on any outstanding student loans (we’ll get into exceptions and nuances here shortly).
- Car Loans and Personal Loans: Monthly payments on any auto or personal loans.
- Mortgage or Rent: For refinancing, your new mortgage payment, or for buying, the projected monthly payment.
Gross Monthly Income
Gross monthly income is simply the total income before taxes. For salaried employees, this includes regular wages, but if you’re self-employed, you’ll use your net income after expenses. Connect With Our Loan Officer for Mortgage Loans
Calculating DTI
To determine your DTI, underwriters take the total of your monthly obligations and divide it by your gross monthly income. Here’s an example:
Example: If you have $2,000 monthly debt payments and make $6,000 in gross income, your DTI ratio is $2,000 ÷ $6,000 = 33%.
Special DTI Rules on Common Loans in 2024
FHA Loans
FHA loans‘ current DTI limits are 46.9% for front-end DTI and 56.9% for back-end DTI with an automated underwriting approval. FHA loans can also be approved with manual underwriting and stricter DTI limits.
VA Loans
VA loans technically have no maximum DTI ratio if the borrower has enough residual income. This can be particularly helpful for veterans or active military who might have more flexibility with higher DTIs.
Conventional Loans
The typical maximum debt-to-income (DTI) ratio for a conventional loan is 50%. Keeping DTI low can enhance applicants’ likelihood of approval, particularly when submitting applications with Fannie Mae or Freddie Mac.
USDA Loans
The DTI limits for USDA loans are 29% for the front end and 41% for the back end. This is stricter, as USDA loans are often for rural properties and typically involve lower down payments.
DTI Exemptions for Certain Payments
Co-signed Loans
Imagine you agreed to co-sign a loan for a friend or family member but can demonstrate that you aren’t the one making the payments (for instance, by presenting 12 months of bank statements or canceled checks that show their payments). In that case, an underwriter may exempt this debt from your DTI ratio.
Family-Paid Student Loans
Another DTI exemption is for student loans paid by someone else, such as a parent. If you can prove that your parent has been paying the student loan bill, that debt may not count in your DTI.
Deferred Student Loans
Under FHA’s updated guidelines, deferred student loans are no longer exempt from DTI. Instead, FHA lenders calculate 0.5% of the loan balance as the monthly debt for DTI, even if payments are currently deferred.
Income-Based Repayment (IBR) Plans and DTI
FHA vs. Conventional Loan DTI
FHA loans often don’t count IBR payments because they might fluctuate. However, conventional loans may accept IBR amounts if documented accurately. If you’re on an IBR plan, consult your lender to understand which loan types work best with your DTI.
Optimizing DTI
Borrowers on IBR plans can sometimes request an extended term, like 20-25 years, from their servicer, resulting in lower monthly payments. This lower amount could improve your DTI and open the door to more loan options.
How to Lower Your DTI to Qualify for a Loan
If you’re aiming to improve your DTI before applying, here are some practical steps:
- Pay Down Small Debts: Reducing credit card balances or paying off small installment loans can lower monthly obligations.
- Focus on High-Interest Debt: Clearing debts with higher interest can improve your financial picture and reduce monthly costs.
- Increase Your Income: Side jobs or overtime can raise your gross monthly income, lowering your DTI.
Pre-Approval Strategy
Talking to a mortgage expert can provide valuable insights on modifying your finances to meet qualification criteria. They can provide personalized guidance suited to your specific financial situation. Speak With Our Loan Officer for Mortgage Loans
Loans with Fewer than 10 Payments Left in Their Term
DTI Exclusion
If you have installment loans (like an auto loan) with less than 10 months of payments left, underwriters can usually exclude these from DTI calculations. This doesn’t apply to leases, which usually must be included in your DTI regardless of the remaining payments.
Example: Say you’re paying $300/month for a car loan, and you only have 8 payments left. This payment may be omitted from your DTI ratio, which can make a difference in qualifying for a loan.
Lender Overlays on DTI Ratios
Understanding Overlays
Some lenders add extra requirements, called “overlays,” to agency standards. For instance, FHA’s guidelines might allow a DTI of 56.9%, but some lenders cap it at 50%.
Choosing a Flexible Lender
To avoid restrictive overlays, look for lenders known for flexibility, like Gustan Cho Associates. These lenders work with borrowers needing higher DTIs without adding extra requirements.
How a Low DTI Can Help You Get Approved Faster
More than Just a Ratio
Lenders see a low DTI as a “green light,” meaning less risk. A low DTI may result in faster approvals, sometimes giving you a better loan rate and saving you money long-term. It’s one of the most impactful steps you can take to ensure smooth approval.
Contact Gustan Cho Associates for DTI-Friendly Mortgages
If you’re unsure about your DTI or want help getting qualified with no overlay requirements, contact Gustan Cho Associates. Our team understands how to help borrowers with unique financial situations get approved.
We’re available every day of the week – evenings, weekends, and holidays included. Call us at 800-900-8569, text for a faster response, or email gcho@gustancho.com. Let’s help you make homeownership a reality! Speak With Our Loan Officer for Mortgage Loans
Frequently Asked Questions About How Underwriters Calculate Debt-To-Income Ratio
Q: What is a Debt-to-Income ratio (DTI), and Why Does it Matter for my Mortgage?
A: Understanding how underwriters determine the debt-to-income ratio (DTI) is essential since it indicates the portion of your income allocated to debt payments. A reduced DTI can enhance your likelihood of being approved for a mortgage.
Q: How do Underwriters Calculate the Debt-to-Income Ratio (DTI)?
A: Underwriters determine the debt-to-income (DTI) ratio by summing your monthly debts and dividing that total by your gross monthly income. This ratio assists lenders in assessing whether you are capable of managing a new mortgage.
Q: What Debts are Included When Underwriters Calculate DTI?
A: Monthly payments like credit cards, car loans, student loans, and housing costs are included when underwriters calculate debt-to-income ratio (DTI).
Q: How High Can my DTI be to Still Qualify for a Mortgage?
A: Most lenders prefer a DTI below 50% for conventional loans. However, depending on the lender, FHA and VA loans may have higher allowances.
Q: What’s the difference between front-end DTI and back-end DTI?
A: Front-end DTI includes only housing costs, while back-end DTI covers all monthly debts. Both are used when underwriters calculate DTI for mortgage approval.
Q: Can I Improve my DTI to Get a Better Chance at Mortgage Approval?
A: Absolutely, individuals can improve their debt-to-income (DTI) ratio by reducing outstanding debts or boosting their income. Achieving a lower DTI could significantly enhance prospects for securing more favorable loan terms.
Q: Does my Co-Signed Loan Affect my DTI?
A: If someone else makes payments on the co-signed loan, you might be able to exclude it from your DTI, but you’ll need proof of their payments.
Q: What if my Student Loans are Deferred? Will They Still Count in my DTI?
A: Some loans, like FHA loans, may count as a percentage of deferred student loans. Check with your lender to see how they calculate this.
Q: Are There Exceptions for Certain Debts When Underwriters Calculate Debt-to-Income Ratio (DTI)?
A: Yes, debts with fewer than 10 payments left may be excluded from DTI. This can affect whether you qualify for a loan.
Q: Why Does a Low DTI Make me More Attractive to Lenders?
A: A low DTI shows that you have room in your budget for a mortgage, making you a safer bet for lenders. It can even lead to faster approvals and better loan terms.
This blog about “How Underwriters Calculate Debt-To-Income Ratio” was updated on November 6th, 2024.
