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Understanding the Debt-to-Income Ratio – How it Impacts FHA & Conventional Loan Approvals

Mortgage qualification is based on the following intrinsic underwriting questions –

  • Will the borrower repay the mortgage debt? — This answer is revealed by reviewing the borrower’s credit history/report.
  • Can the borrower repay the mortgage debt? — This answer is revealed by analyzing a borrower(s)’ Debt-to-Income (DTI) ratio.
  • What is the quality and value of the loan’s collateral — the subject property, should the borrower(s) default?

What is a Debt-to-Income Ratio?

A debt-to-income ratio (DTI) is a mathematical calculation the demonstrates the percentage of a borrower’s income that is being used to carry recurring debt. In essence, a debt-to-income analysis that meets underwriting criteria offers a reasonable expectation that a borrower will meet their homeownership obligations.

Mortgage lenders generally use 2 DTI ratios to assess the quality of a mortgage loan accurately.

  • The Front-Ratio — represents the percentage of gross monthly income that is allocated for housing debt only. This would generally include the Principal, Interest, Taxes, and Insurance (PITI).
  • The Back-Ratio — represents the percentage of gross (pre-tax) monthly income that is allocated towards all the borrower’s monthly recurring debt, i.e., car loan, student loan, car lease, or credit card, etc.

Example –

If a borrower earns $5,000/month and has a monthly PITI payment of $1,250 plus a car loan of $350/month, what are the DTI ratios?

  • The front Ratio is calculated as follows — $1,250/$5,000 = .25, or 25%. This means that a borrower uses one-quarter of their gross monthly towards the monthly housing expense.
  • Back Ratio is calculated as follows — ($1,250+$350)/$5,000 =.32 or 32%. This means that a borrower uses nearly one-third of their gross monthly towards their entire monthly debt.

The FHA DTI Limits for 2019

The Federal Housing Administration’s (FHA) DTI limits for 2019 are –

  • For the Front Ratio — 31%.
  • For the Back Ratio — 43%.

The Conventional Mortgage DTI Limits for 2019

Conventional mortgage loans are generally underwritten with an analysis of the Back Ratio only. Most conventional mortgages use a 45% DTI limit for its underwriting approvals. However, for exceptional circumstances, with influential compensating factors, the maximum DTI ratio for a conventional mortgage is 50%.

Based on the above example, the borrowers would qualify for a conventional mortgage loan.

Please reach out to us if you have any questions – we’d love to help you with our complimentary consultation with one of our loan officers!

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