December 27th, 2016 5:35 PM by Dana Bain
Mortgage lending underwriting criteria falls into three general categories, credit, collateral, and capacity. Credit has to do with how well you pay your bills (as evidenced by a credit report and score), collateral has to do with the type and quality of the property you’re using to secure the loan, and capacity has to do with your financial ability to repay the loan. Your debt-to-income ratio falls into the latter category – capacity – and is considered an important factor in determining your financial ability to pay back your mortgage.
Your debt-to-income ratio, or DTI, expresses in percentage form how much of your gross monthly income is spent on servicing liabilities such as auto loans, credit cards, mortgage payments (including homeowners insurance, property taxes, mortgage insurance, and HOA fees), rent, credit lines, etc.
Living expenses such as cable, gas, electricity, groceries, etc., are not considered part of your DTI.
If your DTI is high, it means you are highly leveraged and have tight finances, which, naturally, is considered risky from a lending standpoint. On the other hand, if your DTI is low, the lender knows you have plenty of room in your monthly budget to absorb unexpected expenses and still make your mortgage payments.
In today’s mortgage marketplace, the maximum DTI allowed is 45% for Fannie Mae loans and 50% for FHA-insured loans. In other words, for a Fannie Mae loan, no more than 45% of your gross (pre-tax) monthly income can go to debt service and mortgage and housing-related expenses.
Both Fannie and FHA allow for higher DTIs under limited circumstances, but these are the standard guidelines.
If you’re in the market for a home loan, it doesn’t hurt to calculate your debt-to-income ratio ahead of time so you know where you stand. To do this, simply tally up your total monthly debt obligations and divide by your gross monthly income, as follows:
If you’re self-employed, I recommend working with your loan agent to determine your qualifying DTI. Self-employed income verification is more complicated and there’s really no way to determine your qualifying income definitively without tax returns.
Keep in mind that when you’re qualifying for a home loan, your qualifying DTI will be based on what your expenses will be after the loan is complete. In other words, if you’re currently renting and are taking on a house payment higher than what you’re paying for rent, your qualifying DTI will be based on the new mortgage payment. If you’re refinancing and consolidating debts, your qualifying DTI will reflect your expenses after the various debts are consolidated.