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.
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!