Qualifying for a mortgage involves several calculations. One of the most important numbers in the mortgage process is a borrower’s debt to income ratio (DTI).
What Does Debt to Income Ratio Mean?
Debt to income ratio is a borrower’s monthly debt payments divided by their gross monthly income. A very common question is, “What is a good debt to income ratio?” Although it sounds pretty simple, it is a complicated question. Not only does the answer depend on the loan program, but it is also based on other borrower qualities such as credit score, down payment, and more. If you want a quick response, the answer would be the lower the debt ratio, the better. Chances are, you are seeking a better answer than this, so let’s dig in!
There Are Two Types of Debt to Income Ratio
There are two DTI (Debt to Income) types. First is the housing ratio. Also called the front ratio, it is calculated by dividing the monthly debt payments by the gross monthly income. Second is the total debt ratio or back ratio. When someone asks “What is the maximum debt ratio?” usually, it references the total debt ratio. The total debt to income ratio includes both the total housing payment and the other monthly payments.
What is included in the Housing / Front Ratio?
Included in the housing ratio are the proposed mortgage principal, interest, property taxes, insurance payments, mortgage insurance, and/or HOA dues. Depending on the loan and property, there may not be HOA dues or mortgage insurance. Here’s a tip. There are ways to cancel PMI if you have to get it in the beginning. Learn how to cancel mortgage insurance in another OVM article. Even if a borrower decides to pay their taxes and insurance, they are still in the front debt ratio.
What is Included in the Total Debt Ratio?
In addition to the housing payment, there are other debts included in this calculation. These payments include installment, revolving, other housing payments for other properties, IRS or state income tax payment plans, garnishments, alimony, child support, car leases, and possibly others. Though, 401k loan payments are excluded from debt ratio calculations.
Automated Approval vs. Manual Approval – Debt to Income Ratios
Before explaining the differences between loan program debt ratios, there are traditional (manual) debt ratio limits, possible DTI exceptions, and then automated approval DTI limits. Manual debt ratios are set at certain front and back limits. These apply if a borrower’s scenario does not receive an automated pre-approval through an automated system. The primary automated approval engines used by lenders are Desktop Underwriter (DU), Loan Prospector (LP), and Guaranteed Underwriting System (GUS). With compensating factors, most loan programs allow exceptions to exceed the manual ratio limits. Often, automated approvals allow higher debt to income ratios. Automated approval DTI levels vary widely. Basically, it is weighing all factors in the background and deciding if there is an acceptable risk. In these cases, ratios may far exceed traditional guidelines. Although, some lenders stick to the manual ratios.
|Loan Type||Manual DTI||Possible Exceptions||Automated Max DTI|
|VA||41% total||Must have 120% residual||55% +|
What is a Good Debt to Income Ratio For Each Loan Type?
Notice the chart above which explains manual, possible exceptions, and automated maximum ratios.
USDA Loan Debt Ratio
USDA debt to income ratio limits are very strict when it comes to manual underwriting and maxes out at 29/41%. With a 680 credit score and other compensating factors, 32/44% is possible. But, with an automated GUS approval, we have seen approvals that hover up to 46% total ratios.
FHA Loan Debt Ratio
VA Loan Debt Ratio
VA loan maximum debt ratio is 41% for manually underwritten loans, but it allows exceptions. If the borrowers have residual income which is 120% of the required for their family size, exceeding 41% is possible. Like FHA, automated approvals allow over 55% DTI. Also, VA loans rely heavily on residual income which is the discretionary income left over after paying debts. So, VA loans really look at debt to income ratios and residual income.
Conventional Loan Debt Ratio
Fannie Mae and Freddie Mac conventional loans usually require an automated approval. Although, there are a few lenders that offer manual conventional loans. These typically want a 29/36% ratio. Although, the more common automated maximum debt ratio for conventional loans is 50.0%. No exceptions.
DPA Debt Ratio
Even though not on the chart, down payment assistance programs have maximum debt ratio limits as well. Most DPA programs limit debt ratios to 43%, maybe 45%. For instance, NC down payment assistance is firm on a maximum 43% DTI. Where SC down payment assistance offers a 45% maximum DTI.
So, What is a Good Debt to Income Ratio?
Again, tough to answer, but a good goal for borrowers would be a maximum 29% housing ratio and 41% total DTI. Thus, a borrower should qualify for most programs available. Borrowers with compensating factors like higher credit scores, assets, or down payment could very possibly qualify with 55% or more debt ratio.
It is always a good idea to budget yourself. Just because a lender says your debt to income ratio works, doesn’t mean you can make it happen. There are other areas in a family’s budget. These include medicine, doctor bills, utilities, daycare, and car maintenance that do not affect loan approval. Yet, they certainly affect a family’s bottom line. So, even if approved, ensure that the mortgage payment works for you and not just the loan program.