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Debt to Income Ratios for Home Loans

Einstein's Theory of Mortgage Lending Ratios

Einstein’s Theory of Debt to Income Ratios

Orange County, CA – Debt to income ratios don’t need to be complex. While we might get bogged down in technical jargon at times, it’s important to simplify the terms that are common in mortgage lending. Simply put, debt to income ratios are an investor’s tool for determining your budget. Finding out just how much money you can spend on your next house is as important as it gets. What are your specific debt to income ratios? Of course, there’s no definitive answer to this question, because everyone has different circumstances and there are different limits for each loan program. But we will break down how to calculate your personal debt to income ratiso and review the investor guidelines.

There are two debt ratios to consider:

  1. Housing Debt Ratio – This ratio calculates the percentage of your housing payment in relation to your gross income. The housing payment includes principal, interest, taxes, hazard insurance, mortgage insurance and HOA fees. This is also known as the “top” or “front-end” debt to income ratio.

Lenders will normally look for a front end DTI of less than 29%. By this they mean that the buyer should be able to cover all of the above payments with less than 29% of his or her monthly pay. However, investors are less stringent about the housing ratio than the total debt ratio.

  1.  Total Debt Ratio – This ratio calculates all of your financed debt in relation to your gross income. In addition to the housing payment, your credit card payments, car payments, child support, alimony payments and other liabilities will be factored in. This does not include utility payments or normal household expenses. This is also known as the “bottom” or “back-end” debt to income ratio.

For example: Let’s calculate the ratios for a borrower with a $2,000 principal and interest payment, $300 property taxes and $75 hazard insurance. This borrower also has a $350 car payment, minimum monthly credit card payments of $200 and child support of $500/month. Their gross monthly income is $10,000. Therefore we have the following:

Housing ratio: $2,000 + $300 + $75  = $2,375/$10,000 = 23.75%

Total ratio: $2,375 + $350 + $200 + $500 = $3,425/$10,000 = 34.25%

Our Debt to Income ratios would be 23.75%/34.25%.

 

Investor Requirements for Debt to Income Ratios

Conventional Loans: The general rule is that the total debt ratio should not exceed 45% for conventional loans. However, Fannie Mae and Freddie Mac do have flexibility here and can go as high as 50% with strong compensating factors.

FHA Loans: For FHA loans the stated maximum for total debt is 43%. This is used if the loan must be manually underwritten. However, the automated underwriting system regularly approves higher limits. It’s common to see total debt ratios go as high as 55% for FHA approved loans.

VA Loans: The ratios for VA loans are similar to the FHA requirements. First and foremost we follow the recommendation of the automated underwriting system. Again it’s not uncommon to see tot al debt ratios approved at, or even above, 55%. If manual underwriting is required you’ll need to keep that ratio at or below 41%, with some leniency for strong compensating factors.

USDA Loans: The USDA is the most rigid with their debt to income ratios. They want to see the housing ratio at or below 29% and the total debt ratio at or below 41%. There is some leeway given by their automated underwriting system. But once again, strong compensating factors will be required.

The best thing you can do as a prospective buyer? Put together a monthly household budget. Of course, you can always let a loan officer tell you how much you can borrow, but often times you can qualify for more then you’re comfortable paying. Know your comfort range. Only you know exactly what you spend your money on and how much you have to spend on housing.

A good way to do this is to figure out a maximum monthly payment you would be happy making towards housing. With this figure we can back into a comfortable loan amount by backing out the estimated taxes and insurance payments.

Once you’ve done this, enlist the help of a mortgage expert. You’ll find their help invaluable in letting you know what programs will work for you and what you can truly spend on a mortgage.

I would be happy to help you determine how much of a loan you can comfortably afford. Contact me anytime!

 

 

Scott Storace

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