Understanding the Debt-to-Income Ratio to Qualify for FHA Loans

One of the most important factors in qualifying for an FHA home loan is the debt-to-income ratio. In this post I will explain this so you can be aware of your own debt-to-income ratio and make sure it is where you need to qualify for an FHA loan.

There are 2 different important ratios FHA underwriters look at when approving a FHA loan. The first is your housing ratio or “front ratio”. This is simply taking your TOTAL housing payment (monthly mortgage payment + monthly mortgage insurance + property taxes divided by 12 + homeowners insurance divided by 12 + monthly condo HOA if you have it) as a percentage as your total gross (before tax) monthly income. So if your total housing payment is $2,000 per month and your gross monthly income is $6,0000, $2,000/$6,000=33%. So your housing ratio is 33%.

The more important ratio looked at for qualification for an FHA loan is your “back-end ratio”. This is your total housing payment + all the total of all other monthly payments that show up on your credit as a percentage of your gross income. So if you have a housing payment of $2,000 + a $200 auto loan payment + $100 student loan payment + $50 minimum monthly credit card payment, your total debt for the purposes of the back-end ratio would be $2,350. So take $2,350 and divide it by $6,000 gross income and you have a 39% back-end ratio. Items such as utilities, car insurance, cell phone payment, etc… are NOT counted in this ratio. It is only your total housing payment + items that appear on your credit (most commonly auto loans, student loans and credit cards, personal loans).

So in this case a 33% front ratio and a 39% back ratio would qualify for an FHA home loan as long as the borrower meets all of the other guidelines (job history, credit score). The maximum ratios can be much lower for what is called a “manual underwrite”. A manual underwrite is generally done only if you have below a 580 credit score. In this case you have to start out with a 31% maximum housing ratio and a 43% back ratio. The underwriter does have wiggle room if you have compensating factors.

But if you have average to good credit, the maximum ratios can be much higher than 31/43 above. Generally you can get up to 50% back-end ratio and possibly above if you have other compensating factors (solid credit, cash reserves). But regardless of the maximum ratios, the most important thing for your as a homeowner is only taking on a housing payment that you feel you can comfortably afford.

Some tips to keep in mind if you feel like your debt-to-income ratio for a FHA home loan is too high for the house you want to buy or on the borderline:

• Try to buy your auto with cash or pay it off early so you remove that payment from your debt-to-income ratio calculation
• You might be able to refinace your auto loan to lower your payment or auto loan interest rate
• Try to pay off your credit cards and either carry a small balance or none at all
• See if you can get your student loan payments deferred for 12 mos or more (then these payments do not have to be included in your DTI). But keep in mind that you will have to make these payments eventually, so only take on a housing payment that will allow you to do this in the future

Written by Rob Chomentowski.

See full article here.