What Is the Debt to Income Ratio Needed to Qualify for a FHA or Conventional Mortgage?
Your debt-to-income ratio is a very important figure to know since it will determine whether you can qualify for loans or not. In fact, your FHA debt to income ratio and Conventional debt to income ratio to get an approval is key. It helps you to see where you stand with your finances. What is this magical number? What are the requirements for different loans? Here is your guide to the debt-to-income ratio.
The debt-to-income ratio is a figure that shows the relationship between your debts and your income, expressed as a percentage. It shows the percentage of your income that is taken up by debt payments.
Monthly Debts: All debts are included in the ratio. Existing loans, credit card payments, and other bills are taken into consideration. The are no upfront or annual costs, only monthly payments for each debt are considered. Your lender will also include the obligations for the loan you are applying for when they calculate your debt-to-income ratio, so they can make sure you can cover the costs of the loan without issues.
It’s important to note that this ratio includes debts, not expenses. What’s the difference? Debts are costs that you are responsible for paying until they are one day paid off. However, expenses are never paid off. They include things like insurance payments, everyday expenses such as groceries, and costs associated with entertainment and dining out. The debt-to-income ratio will not provide insight into how you are managing these expenses, so that is something you will need to look at yourself.
Income, for the purposes of the ratio, means your gross monthly income. This is what you earn before taxes and other deductions are taken.
To get to your debt-to-income ratio, you would divide your debts by your income. This will give you a percentage. The higher the percentage, the more your debts are catching up to you. This will make it difficult to pay an additional loan. Lower percentages indicate you have a financial “cushion” – meaning you are on top of your debts and have plenty of breathing room. This would tell a lender that you could easily take on another debt without problems.
Debt-to-Income Ratio FHA Requirements
Debt to Income Ratio for Mortgage: FHA loans can be used to buy a home, but they are a bit easier to qualify for than conventional loans. FHA loans are insured by the Federal Housing Administration and provided by mortgage lenders. The federal backing gives lenders more confidence that they will be repaid and makes them more willing to take chances on borrowers who otherwise might have been regarded as too high-risk. Requirements are a bit more relaxed, making it easier to qualify.
FHA Loan Requirements: In order to qualify for an FHA loan, the debt-to-income ratio is still required. While most conventional loans look for an overall ratio of 43 percent or below, FHA loans actually look at two different types of debt-to-income ratios: front-end and back-end.
Mortgage Income Ratio: A front-end debt-to-income ratio only looks at housing-related debts. This could include property taxes, homeowners insurance, and potential mortgage payments for the FHA loan being applied for. The front-end ratio should be 31 percent or lower to qualify for an FHA loan.
A back-end debt-to-income ratio looks at all debts and income. This is the ratio that conventional loans will look at as well, requiring a ratio of 43 percent or lower.
Much like conventional loans, there could be exceptions if these ratios are higher, depending on the state of your employment history, credit score, and other factors. Borrowers with good credit could even obtain a loan with a debt-to-income ratio of up to 50 percent, though you would need to make sure you can make payments with a ratio that high.
Debt-to-Income Ratio Requirements for Conventional
Mortgage to Income Ratio: In most cases, the highest debt-to-income ratio a borrower can have to qualify for a mortgage loan is 43 percent. This is the number that lenders have determined will allow someone to stay on top of existing debts, handle the new debt, and still have money to live on.
However, some lenders may accept ratios higher than 43 percent. All lenders will at least consider your debt-to-income ratio, but some smaller lenders may accept higher ratios. This will require quite a bit of faith on the part of the lender and will depend on other factors, such as your credit. Your debt-to-income ratio is just a small piece of the puzzle when you apply for a mortgage loan. If you have a good credit score, especially if your credit includes a good payment history, this may make up for a ratio that is higher than 43 percent.
It’s important to remember, though, that these lenders may add features to the loan that may make it difficult to pay for now or pay off later, such as excessive fees or loan products that are negatively amortizing. And of course, the higher risk you have, the higher your interest rate will be.
Most lenders and financial experts agree that the ideal debt-to-income ratio is around 36 percent. This gives you plenty of room for debts and living expenses. It also makes you a lower risk for lenders, which will not only qualify you for mortgage loans, but also allow you to attain lower interest rates. This saves you money on the loan in the long run. A good practice is to shoot for 36 percent as a maximum, but strive for an even lower debt-to-income ratio. The lower your ratio, the more attractive you look to lenders.
Pay Attention to Your Debt-to-Income Ratio to Improve Your Chances with Lenders
Whether you are applying for a mortgage loan or not, you cannot afford to ignore your debt-to-income ratio. At the very least, it will help you determine your financial standing and make improvements. It will also increase your chances of achieving a mortgage loan with lower interest rates. Before you ever apply for the loan, you should calculate your debt-to-income ratio and determine if you need to make changes. If your ratio is too high, try reducing debt or increasing income. This will lower your ratio and your risk.