FHA Loan Debt to Income (DTI) Ratio Guidelines
FHA loans allow first time home buyers and others who are just starting out or who may be financially disadvantaged to purchase homes through a government assisted program that differs from conventional loans. To qualify for an FHA loan, the Federal Housing Authority requires that you meet certain criteria.
Among the factors for determining whether you are qualified for an FHA loan is a metric that’s referred to as a Debt-to-Income Ratio or DTI Ratio. The DTI ratio compares the amount of debt payments you’re obligated to pay each month to the amount of income you bring in each month. Acceptable DTI ratios vary depending upon your credit score and other factors. In general though, to qualify for an FHA loan, your front-end ratio (debts related to housing only compared to your income) must be less than 31%, and your back-end ratio (which compares all of your monthly debt obligations to your monthly income) must be 43% or less.
For people who have good credit (580 and above), the DTI ratios can be as high as 40% (front-end ratio) and 50% (back-end ratio).
|Credit Score||FHA Maximum Front-end DTI Ratio||FHA Maximum Back-end DTI Ratio|
As you can see from these numbers, when you’re applying for an FHA loan, your allowable DTI ratios are evaluated in context of your overall trustworthiness, especially as that metric is measured by your FICO score. Having a FICO score at 580 or higher allows you to have higher DTI ratios and still qualify for an FHA loan.
How DTI Factors into Lenders Calculation of Risk
Before I explain more about DTI limits and explain the exceptions to the standard FHA rules, it’s useful to know why FHA (similar to other lenders) place requirements on how much debt you’re able to have compared to your income.
Why Your Debt Ratios Matter to FHA Lenders
When lenders grant a loan request to a borrower, it’s important for the lender that the loan agreement be kept, including that the borrower will pay back the loan as agreed in the mortgage contract. If a potential borrower has a high amount of monthly debt obligation compared to income, there is much more likelihood that the borrower will not be able to make payments on the loan, and the loan will go into default. Defaulted loans are highly desirable by lenders and by the FHA, who normally lose money and waste resources when loan agreements are not kept.
Your DTI ratio is a significant factor the lender will use to determine whether you are too much of a risk for them. But there are other factors as well.
Other FHA Loan Qualification Factors
When assessing how much of a risk a potential borrower presents to an lender, the lender considers several other factors in addition to the DTI Ratios, including:
- your credit score
- your employment history
- how much money you’ll be using for a down payment
A Word of Caution Regarding DTI Ratios
When considering your debt to income ratio, it is important to remember that you are the ultimate decision maker when it comes to your finances. You need to be comfortable with whatever level of debt you choose to take on. If my credit score was less than 580, I personally wouldn’t consider it a wise choice to have as much as 31% of my income going to mortgage and other housing costs and 43% of my total income obligated to debt payments. Instead, I would simply find a cheaper house.
The allowable ratios for FHA loans and other loan types should be considered worst case scenario guidelines for you in your personal financial strategy. You are the best source of knowledge about your discipline with regard to spending habits. You also should have a solid, realistic understanding of your current and future earning potential.
You should be planning ahead for upcoming expenses that might include a new child entering your family, potential medical treatment you might need in the coming months, and other factors you need to consider that don’t show up on paper in the initial evaluation of your current debts.
How to Calculate Your DTI Ratios
There are several online debt to income ratio calculators available online. Also, the lender you work with to secure your loan should be experienced at calculating these ratios, since meeting the DTI requirements is part of the screen process for a loan application.
Before you begin to apply for a loan, it’s a good idea to go ahead and calculate your DTI ratios manually, so that you can prepare for a loan application by fixing those ratios, either by increasing your income or by paying off debts. Here’s how to calculate your current DTI ratios.
Determine Your Monthly Income:
Add up your monthly income. For the majority of people, this will involve simply looking at the paystub you get from your employer. For the purposes of calculating your DTI, the figure you use for your monthly income is your pre-tax income amount.
If you have other monthly income, such as investment dividends, income from a spouse, child support, or any other income, add that to the pre-tax income you receive from your job.
Note: Having a regularly updated knowledge of the details of your monthly income is important for being financially responsible, including for setting a budget. If this is your first time calculating your monthly income, I highly recommend getting into the habit of doing it regularly.
Front-end Ratio: Add Up Housing Related Costs
If you know your credit score and have an idea of the amount you’re planning to spend on a house, you can estimate how much home related debt you’ll be obligated to pay monthly. Include in your estimation these items:
- Mortgage payment
- Mortgage insurance (if your down payment is less than 20% of the loan amount)
- Home insurance
- Homeowners association dues (if applicable)
Once you’ve estimated these numbers, add them up, then divide that number (your total housing costs estimate) by the number you calculated for your monthly income. This number is your front-end debt-to-income ratio. If it’s higher than 31% and your credit score is under 580, you don’t yet qualify for an FHA loan. If your credit score is 580 or above, this front-end ratio number can’t be higher than 40%
Back-end Ratio: Total Debt
Now that you’ve calculated your front-end ratio, it’s time to compare your total debt to your income.
Make a list of all the monthly payment obligations you have related to the following:
- Credit cards
- Student loans
- Child support
- Car loans
- Any other monthly debt obligation
Now, add these numbers together, then add to them the estimate you got from your total housing costs. This number is your estimated total debt obligation you’ll have after you have been granted your loan. Divide this number by your total monthly income. If your credit is lower than 580, this back-end ratio number can’t be higher than 43%. If your credit is 580 or above, this back-end ratio number can’t go above 50% to qualify for an FHA loan.
Improving Your Debt to Income Ratio
It is clear from the methods of calculating debt to income ratios that they can be changed and improved by reducing debts and increasing income.
Pay Off Debts
Most people look at their debts with at least some regret about decisions made in the past, especially in a situation where their debts prevent them from accomplishing something they want, such as qualifying for a home loan.
The good news is that debts don’t have to stick around. If you commit yourself to a goal of paying off debts, your life becomes more meaningful, you have more flexibility, and in the context of DTI ratios, you can qualify yourself for a home loan.
I highly recommend programs such as Dave Ramsey’s 7 Baby Steps to begin paying off debt and saving money to prepare yourself for buying a home.
Increasing Your Income
Besides asking your boss for a raise, there are lots of ways to increase your income, including taking on a second part-time job or by setting yourself with a legitimate work from home opportunity. I’ve written on this website about several work-from-home opportunities, including being a freelance writer.
If your current career track isn’t getting you where you want to be financially, you may want to consider the possibility of updating your resume and making a switch into a technology-related field. For many, learning a technical trade through one of the coding bootcamps that are popping up everywhere can take only a few months, costs much less in terms of money and time than a college degree, and increase your earnings as much as double what they’re making elsewhere.
If you’re interested in quickly increasing your income to prepare for purchasing a home or simply to improve your overall financial situation, it may be time to consider a career change option through a technical training and certification program.
As your income goes up, even by as little as a few hundred dollars each month, and as you pay off debts following a structured plan, you’ll see that you are much better qualified for a home loan.
Hopefully this article has provided you with the information you need to assess whether you’re ready to apply for an FHA loan.