*As of July 6, 2020, Quicken Loans is no longer accepting USDA loan applications.
When it comes time to get a mortgage, one of the pieces of advice everyone seems to give is to keep your debt in check. But why is that important? In addition, what sort of measuring stick can you use to determine where you stand with your debt? What’s considered debt to begin with?
This post will help you answer these fundamental questions so you’re ready to apply when the time comes.
What Is Debt-To-Income Ratio (DTI)?
Taken together with your down payment savings, debt-to-income ratio (DTI) is one of the most important metrics mortgage lenders use in determining how much you can afford. Your DTI has a direct bearing on the monthly payment you can qualify for when getting a mortgage.
DTI is a ratio comparing the monthly payments you make on existing debts with your gross monthly income before taxes. Depending on the type of loan you want and your qualification metrics, there are two types of calculations that are often used in mortgage qualification: a front-end DTI and a back-end DTI.
A front-end DTI or housing expense ratio takes a look at the amount you spend on housing as compared to your total income. This calculation is used on certain government loans if you might be considered a little bit more of a risk. For example, if you’re getting an FHA loan with a FICO® Score below 620, you’ll have to have a housing expense ratio no higher than 38%. Here’s how that’s calculated:
No matter what kind of mortgage you’re getting, a back-end DTI is calculated. This takes into account both your installment and revolving debts, and it’s calculated as follows:
Debt-To-Income Ratio Calculation
Let’s see how these formulas work in practice by going through a quick example.
John Doe has an income of $72,000 per year before taxes. His mortgage payment is $1,400 per month. He also has a car payment that’s $400 per month, credit card balances with minimum payments totaling $300 and a $600 monthly personal loan payment.
Let’s take a look at John’s housing expense ratio first. The two key numbers in this calculation are John’s mortgage payment of $1,400 and his monthly income of $6,000. His housing expense ratio is a little more than 23% ($1,400/$6,000 = 0.2333333).
As a reminder, a back-end DTI takes into account all the debts a person has. If we add everything back into the equation, we get 45% ($2,700/$6,000 = 0.45).
What’s Considered A Good Debt-To-Income Ratio?
If you’re trying to get a mortgage, you may be wondering what a good DTI is. As a general rule, the best thing to do in order to qualify for the most loan options possible is keep your DTI at or below 43%. With that said, the exact limitations will depend on your other qualifications and the type of loan you’re trying to get.
It should be noted that the following scenarios are based on the policies of Quicken Loans®. Other lenders may have slightly different standards.
If you’re applying for a conventional loan through Fannie Mae or Freddie Mac, you can have a DTI as high as 50%. As you get closer to the higher end of that ratio range, it’ll sometimes be easier to qualify if you have a lower housing expense ratio on the front end.
Another thing Fannie Mae specifically looks at is your credit card behavior. If you’re someone who pays off most or all of your monthly balance, you’re considered a lower borrowing risk than someone with an otherwise identical history who makes only the minimum payment on their credit cards.
If you’re looking at getting an FHA loan, the qualification metrics will be different depending on your FICO® Score. If you have a median score below 620, you’ll need a housing expense ratio no higher than 38% and no higher than 45% when factoring in all of your other debts. When getting an FHA loan with a median FICO® Score higher than 620, your DTI can be slightly higher. In this case, FHA takes into account a variety of factors including your down payment size, the amount of equity you have and your credit score, among other variables. You’ll never be approved for an FHA loan with a DTI higher than 57%.
On a USDA loan, the DTI you can qualify with depends on a variety of risk factors as well, so there’s no definite number that applies to everyone. However, in no event may your housing expense ratio be higher than 34% and your total DTI exceed 46%.
For a VA loan, qualifying active-duty service members, reservists, veterans and surviving spouses of those who passed in action or as a result of a service-connected disability can get a fixed-rate loan with a DTI as high as 60% and an adjustable rate mortgage (ARM) with a DTI that’s lower than 50%. This can vary depending on your credit score and the size of your down payment or equity amount.
For jumbo loans that have amounts higher than $510,400, you’ll have to keep your DTI anywhere between 40% – 43% depending on the size of your down payment.
A Home Loan Expert will be able to give you guidance and find a loan that works best for you.
What Debts Are Included In Debt-To-Income Ratio?
Not every bill you pay gets counted toward your debts. Typically, the only things that show up are items you get a loan or a credit account for. The easiest way to think about this is that if it shows up on your credit report, it can be included in your DTI.
Here are some of the items included in your DTI:
- Home equity loan/home equity line of credit (HELOC)
- Auto loans
- Student loans
- Personal loans
- Child support payments
- Spousal alimony
- Credit cards
Things like your bills for utilities, cell phones and cable don’t show up on your credit report and aren’t included in your DTI. However, it’s still important to stay current on these accounts. They may show up on your credit report and hurt your score if you have a late payment or the account goes into collections.
Special Considerations For Debt-To-Income Ratio And Your Mortgage
If you’re getting a mortgage, there are several types of loans included in your DTI using the actual monthly payment of the loan or payment amount. These include the following:
- Mortgage payment
- Auto loans
- Personal loans
- Child support
However, there are several types of loans that have special guidelines when it comes to a DTI calculation.
There are many factors that determine how student loans are included in your DTI calculation. The calculation depends not only on the type of loan you’re getting but also on whether the loan is in repayment or in a period of deferment or forbearance.
When the loan is in deferment or forbearance, the following guidelines will apply.
If you’re getting a conventional loan through Fannie Mae or a jumbo loan from somewhere else, we look at the actual payment on the credit report first. If no payment is listed on the credit report or the payment is listed as zero, we qualify you based on you paying 1% of the balance per month. If that amount is too high for qualification, we can also qualify you using the official payment listed on your statement. The payment can’t be estimated.
If the loan is from Freddie Mac, they use the actual payment on the credit report or qualify you based on 0.5% of the outstanding balance. If it’s not showing up on your credit and you don’t qualify with 0.5% of the outstanding balance, we can also use the official payment from the statement.
For USDA loans, the payment is based on 1% of the outstanding loan balance or $10 per month, whichever is greater.
For FHA loans, the payment is what’s greatest: $10, 1% of the outstanding loan balance per month or the actual payment shown on your credit report.
The VA makes this easy because their policies are the same regardless of whether your loan is in deferment, forbearance or repayment. The amount included in your DTI is the greater of either the payment listed on your credit report or 5% of your outstanding loan balance divided by 12. So if you had $60,000 in student loans, your monthly payment for your DTI would be $250 ($60,000×.05 = $3,000/12 = $250).
If your loan is in deferment or forbearance and payback isn’t scheduled to begin within 12 months of closing, the VA doesn’t consider it in your DTI.
Now that we’ve covered what happens if your loan is in deferment or forbearance, what happens when you’re actually repaying your loan? In that case, the following guidelines will apply.
If you’re getting a conventional loan through Fannie Mae, they use the actual payment on the credit report first. If no payment is listed, 1% of the existing balance is used. If that’s too high for qualification, we can use the actual payment listed on your statement including all payments from an income-based repayment plan. This includes $0 payments if you have documentation from your loan servicer showing plan approval before you close.
For jumbo loans, the actual payment reporting on credit is used first. If no payment is listed, 1% of the outstanding balance is used. If that’s too high for qualification, they can use the actual payment as long as it’s not $0.
If it’s a conventional loan through Freddie Mac and the payment on the credit report or student loans statement is any nonzero number, the amount from the report or statement can be used. If the payment on the credit report is $0, they use 0.5% of the outstanding balance.
For FHA or USDA loans, you’re qualified with the greater of the following:
- The actual payment on the credit report
- 1% of the existing balance
If you can show documentation that states the payment information statement will pay off the full balance without your payment increasing, this can also be used to qualify for FHA loans and USDA loans.
The VA guidelines are the same as they’d be if the loan was in deferment or forbearance.
When it comes to alimony, there are different regulations that apply depending on who’s invested in your mortgage.
If you’re getting a conventional loan, FHA loan or VA loan, the alimony payment can be subtracted from your income rather than being included in your debts. This could help you qualify easier.
With a USDA loan or a jumbo loan, existing or agreed-upon alimony payments are considered a debt included in your DTI.
When you qualify for a mortgage, you do so based on the monthly debt payments you have to make. On this basis, you’re not qualified based on the full amount of your monthly credit card balances but rather on the total amount of the minimum payments for your credit card accounts.
Of course, you want to pay as much (if not all) of your credit card balance as you can every month because you’ll reduce the amount of interest you pay or even avoid it altogether. This is also better for your credit score because you’ll be keeping a very minimal credit utilization.
Now that you know how debt is factored into your mortgage, you’re ready to apply. You can get started online with Rocket Mortgage® by Quicken Loans. You can also speak with one of our Home Loan Experts about the best loan option for you at (800) 785-4788. If you have any questions, leave them in the comments below.
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