FHA Debt-to-Income Ratio: Requirements, Limits & How to Qualify
For a home loan application, lenders consider several things when assessing your finances. Not only do they want to understand your credit score and income, but they also look at your debt-to-income (DTI) ratio. Each item helps them understand if you can make payments on your loan.
Keep reading as we explore what a debt-to-income ratio is and the FHA debt-to-income ratio requirements you must meet to ensure your home loan application has a good chance of approval.
Your debt-to-income ratio (DTI) is a percentage that allows lenders to understand how much you pay toward your monthly debts compared to your gross income. Lenders use DTI calculations to assess your risk and determine whether you can comfortably make your monthly mortgage payments.
To determine your FHA debt-to-income ratio, you start by adding all your monthly debt payments together. This could be your car payment, student loan payment, personal loans, and the minimum payment due on your credit cards. You then divide that number by your gross monthly income and multiply it by 100.
Let’s walk through an example.
Assume you have a car payment of $350, a student loan payment of $400, and a credit card payment of $250. Your total monthly debt payments would be $1,000. If your gross monthly income is $7,000, your DTI would be $1,000 / $7,000 or 14%.
When applying for a mortgage, lenders might look at a couple different types of FHA DTI ratios. Let’s look a little closer at both.
Your front-end DTI is how much of your gross monthly income goes toward your housing payment. If you’re renting, this would include your monthly rent payment. If you own your home, your front-end DTI will factor in your mortgage payment, property taxes, homeowners insurance, and HOA dues.
The back-end DTI compares your housing expenses and all other monthly debt payments to your gross monthly income. The example above shows the back-end DTI. Most FHA lenders will look at your front-end DTI; however, the back-end DTI will give them a clearer picture of your finances and ability to afford monthly mortgage payments.
Typically, FHA lenders follow a 31/43 ratio. No more than 31% of your gross monthly income can go toward your housing payment. Plus, no more than 43% of your income can go toward all your monthly debt payments.
FHA DTI limits are slightly different than conventional loans. Most conventional lenders don’t consider front-end DTI when underwriting loans, but they want to see your back-end DTI below 36%.
The FHA DTI ratio is generally more flexible compared to conventional lending. While most lenders prefer your DTI not exceed 43%, some offer a bit of leeway. Certain FHA lenders may allow a back-end DTI as high as 50% if borrowers have specific compensating factors. These include any of the following:
Almost all FHA lenders use automated underwriting systems. If you have a high DTI and are concerned about qualifying for an FHA loan, you can ask for manual underwriting if you have any compensating factors mentioned above. By requesting manual underwriting, you might avoid being denied a loan.
The FHA approaches student loans differently when factoring them into DTI calculations. They offer quite a bit more flexibility. For example, with zero-payment loans, the FHA uses 0.50% of the loan balance when calculating DTI. With deferred loans, conventional lenders (Fannie Mae) use 1% compared to 0.50% for FHA loans.
These differences can significantly affect a borrower's FHA DTI ratio, making qualifying for an FHA loan much easier than a conventional loan.
When using an FHA loan, you must pay upfront and annual mortgage insurance premiums (MIP), which will raise your monthly mortgage payment. Because of this increase, you also effectively raise your FHA debt-to-income ratio.
If your DTI is close to the FHA limits, you should spend time improving it before applying for a mortgage. Here are a few ways to do so.
One way to lower your DTI is to increase your income. You could take on a side hustle or work additional hours at your day job. However, this is more of a long-term solution. Lenders are hesitant to consider income that has only been present for a short period. Instead, they want to see income with at least two years of history.
Paying off debt is the easiest way to reduce your DTI. Unlike increasing your income, debt reduction can immediately impact your DTI. To pay down your debt, find the way that will work best for you. Two popular methods are the debt snowball and debt avalanche methods. Each of these give you a roadmap to lower your debt quickly.
If you’re purchasing a home with a spouse or significant other, you could add them to the loan instead of applying on your own. When doing so, the lender considers both incomes and DTI ratios. If your partner has a lower DTI ratio, that would lower your combined DTI, making it easier to qualify for a loan.
