Understanding Debt to income ratio…A very important factor when qualifying for a home loan

Since they are so important to a successful mortgage application, here’s a quick overview on what goes into DTIs and why they are such a big red flag. Debt-to-income ratios for home loans are the most direct indication to a bank about whether you are going to be able to afford to repay the money you want to borrow.

Debt ratios for home loans have two components.

The first measures your gross income from all sources before taxes against your proposed monthly housing expenses, including the principal, interest, taxes and insurance that you’d be paying if the lender granted the mortgage you sought.

As a general target, lenders like to see your housing expense ratio come in at no higher than 28% of gross monthly income, though there is flexibility to go higher if other elements of your application are viewed as strong. In May, Freddie Mac and Fannie Mae had a housing expense ratio of 22%. Federal Housing Administration-approved borrowers had average housing expense ratios of 28%.

The second DTI component — the so-called back-end ratio — measures your income against all your recurring monthly debts. These include housing expenses, credit cards, student loans, personal loan payments and others. Under federal “qualified mortgage” standards that took effect in January, your back-end ratio maximum generally is 43%, though again there is wiggle room case by case.

Most lenders making loans eligible for sale to Fannie or Freddie prefer not to see you anywhere close to 43%. In May, according to Ellie Mae, the average approved home purchase applicant had a back-end ratio of 34%. Even at FHA, which tends to be more lenient on credit matters than Fannie or Freddie, the average back-end ratio for buyers was 41%. The average for denied applications was 47%.

A good place to learn more about DTIs and to compute your own is Fannie Mae’s consumer-friendly “know your options” site (www.knowyouroptions.com), which includes calculators and other helpful tools.

Also, most lenders want to see FICO scores well above 700 — Fannie and Freddie averages were in the 755 range in May; FHA average approved scores were a more generous 684.

Bottom line here: If you want to be successful in your mortgage application, be aware of these key turnoff points for lenders and take steps to avoid the tripwires.

(source: Washington Post Writers Group)

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