# Debt to income ratio for buying a home

## What is debt to income?

Debt to income is a simple formula used by lenders to
determine the maximum monthly loan payment. The term debt to
income may sound strange and complicated because of the word
order. So here’s a simple explanation of debt to income.

The lender adds up the “monthly” debt payments (i.e. credit
cards, car payment(s), school loan(s), installment loan payments
and other obligations and divides the total amount of monthly
credit payments by the monthly gross income. The result of the
division is the debt to income ratio.

The lender makes two calculations, the payment calculation is called the "front end" calculation. The lender divides the proposed loan payment by the "gross" monthly income. The second calculation is known as the "back end" ratio. The debt ratio is the total monthly obligations with the proposed loan payment. The proposed monthly payment includes the real estate tax, homeowners insurance, and any other required monthly payment (i.e. flood insurance, earthquake, homeowners association fee, etc.)

Debt to Income Ratio Calculation | ||
---|---|---|

Gross monthly income | $6,000 | |

Monthly Payments: | Front end ratio | Back end ratio |

Proposed Mortgage payment | $800.00 | $800.00 |

Car payment | - 0 - | $250.00 |

Minimum credit card payments | - 0 - | $200.00 |

School loans | - 0 - | $1,000.00 |

Installment loan | - 0 - | $50.00 |

TOTAL | $800.00 | $2,300 |

Debt to income calculation | $800 / $6,000 | $2,300 / $6,000 |

Debt ratio | 13.33% | 38.33% |

## Each loan program has it's own "ideal" debt to income ratio.

The four popular home loan programs, FHA, VA, USDA and conventional mortgages approach the debt to income ratio differently

The debt to income ratios can be greater than the
maximum debt to income ratios with the automated underwriting
systems. You may be surprised to learn that computer programs
make the initial approval decisions on behalf of the lender.

Read more about automated
underwriting

## FHA debt to income ratio

The ideal debt to income ratio for an FHA loan is 31%/43% for
credit scores 580 and above.
The mortgage payment should be no greater than 31% of the
borrower's gross monthly income and with monthly debt (i.e. car
payment, student loans, charge cards, etc.) at 43%. However, the
FHA will permit the borrower to go as high as 40% for the
monthly mortgage payment and with monthly debt at 50%. There are
strings attached.

Read
more about the FHA debt to income requirements

## VA home loan debt to income ratio

The Veterans Administration does not have a front end payment
ratio, only a debt ratio. The "ideal" debt to income ratio is
41%. Once again, the back end ratio is the proposed mortgage
payment and monthly debt requirements. However, if the borrower
does not have any monthly debt, the monthly payment could go as
high as 41%. But there's a catch. The VA also uses a calculation
called "residual income".

The residual income calculation backs out federal, state, local
taxes, the proposed mortgage payment, and all other monthly
obligations such as student loans, car payments, credit cards,
etc., from the monthly paycheck(s). Also included in the
residual analysis is the cost for maintenance & utilities. The
number of occupants also affects the calculation. The goal of
this estimate is to determine whether there is sufficient money
left over to pay for groceries and other living expenses.
VA residual income calculator.

VA’s debt-to-income ratio is a ratio of total monthly debt payments (housing expense, installment debts, and so on) to gross monthly income. It is a guide and, as an underwriting factor, it is secondary to the residual income".

Source: VA Pamphlet 26-7, Revised Chapter 4: Credit Underwriting

## Conventional home loan debt to income ratio

The FHA, VA, and USDA home loans are backed by the Federal government. The conventional mortgages are loans that are sold to either the Federal National Mortgage Association (Fannie Mae) or the Federal Home Loan Mortgage Corporation. Theses loans do not require upfront mortgage insurance and are identified as loans with down payments of 5, 10, 15 or 20 percent (or more); although Fannie Mae does offer a 3% down payment loan called Conventional 97 for first time home buyers.

The conventional loan traditionally requires a payment ratio of 28%, however, upon searching the Fannie Mae Single Family selling guide, published on August 07, 2018, I was unable to find any reference to a payment ratio expectation. The Fannie Mae guidelines call for a 36% debt to income ratio for manually underwritten loans, however, Fannie Mae (and presumably Freddie Mac), will permit a debt ratio as high as 45% if the borrower meets the credit score and reserve requirements.

## USDA debt to income ratio

The USDA loan payment should be at or below 29% of the borrower's monthly gross income and the debt ratio should be 41% or less.

## How do I improve my debt to income ratio?

1. The simplest way to lower your debt to income numbers is
to earn more money. More monthly income means you have more
margin with the payment and debt ratio. Waiting until your
monthly income increases will lower the ratio numbers.

2. Reduce your monthly debt. Pay down your credit cards,
installment loans, etc., but be careful, because if you use your
savings to pay down your credit cards and other obligations, you
may not have enough cash to purchase a home. Another
consideration is the effect on your credit score. Paying down
debt is ok, but paying off your monthly bills can actually lower
your credit score. Only extinguish your monthly debt after
speaking to a mortgage loan officer.

3. Reduce the balance on your credit cards and other bills. The
loan programs often ignore monthly debt if the number of
payments remaining is less than 6 to 10 months, based on the
mortgage program. Again, speak to a loan officer regarding the
pay down on monthly debt.

4. Refinance your student loan payment, credit cards, etc.

5. Reduce your monthly mortgage payment by seeking a lower
interest rate. For
example, if the seller is willing to pay some of your closing
costs, you can use the savings to "buy"
discount points to lower
the interest rate and consequently the monthly payment.

## Student loan payments and debt to income

The lender will use the student loan payment when calculating
the debt to income ratio, however, if the student loan is deferred, and
an estimated payment is not available, the lender will
"estimate" the student loan payment. The monthly student loan
payment will be estimated at 1% of the deferred balance. For
example, if the deferred loan balance is $50,000, the lender
will use $500 as an estimated payment for debt to income
purposes.