FHA loans provide borrowers with flexible financing. Borrowers find the max DTI forgiving enough to qualify. The other requirements of the program are flexible as well. Understanding the debt-to-income ratio requirements is one of the most important factors. Read our report below to see what you need to know.
What is the Max DTI for FHA Loans?
First, let’s start with the absolute max DTI. Right now, the FHA allows a front-end ratio of 31% and a back-end ratio of 43%. This is rather forgiving considering conventional loans have a 28/36 maximum. In some cases, you can even get an exception granted. You must have compensating factors to make up for it, though. We’ll discuss those in detail below.
What is the Front End Ratio?
Now, let’s break the ratios down. The front-end ratio is your housing ratio. It compares your total housing cost to your gross monthly income. Your total housing payment equals:
Principal + Interest+ Taxes + Homeowner’s Insurance + Mortgage Insurance = Total housing payment
This total may not exceed 31% of your gross monthly income.
What is the Back End Ratio?
The back-end ratio is known as the total debt ratio. It is the total of all of your debts, including the new housing payment. It includes debts that report on your credit report, such as:
- Auto loans
- Student loans
- Credit card payments
- Personal loans
The lender adds the payments reporting on your credit report to your total housing payment. This is your total monthly payments. This amount shouldn’t exceed 43% of your gross monthly income.
What is Your Gross Monthly Income?
Gross monthly income is the money you make before taxes. If you make $50,000 per year, your gross monthly income equals:
$50,000/12 = $4,167
This isn’t the money you see on your paycheck, though. The FHA lets you use your total income for qualifying purposes.
If you work on salary, like the example above, it’s easy to figure out your gross monthly income. However, if you work hourly or on commission, it may be harder.
Both types of employees must use a 2-year average of their income. Lenders ask for your tax returns to figure out this average. This allows them to see how much you made over the course of 2 years. It also lets them see what unreimbursed employee expenses you might claim. This amount may have to come off your gross monthly income for qualifying purposes.
How to Calculate Your DTI
Now that you know the figures, it’s time to figure out your DTI.
The front-end debt ratio is simply your housing payment divided by your gross monthly income. Here’s an example:
- Mortgage Payment $1,000 (principal and interest)
- Mortgage insurance $50
- Homeowner’s insurance $100
- Real estate taxes – $500
- Total annual salary $75,000
Total monthly housing payment equals $1,650
Gross monthly income equals $5000
Front-end DTI equals $1,650/$6,250 = 26%
Taking it one step further, let’s look at the monthly debts:
- Credit card minimum payment $55
- Auto loan $250
- Student loan $200
Total monthly expenses with housing equals $2,155
The back-end debt ratio equals $2,155/$6,250 = 34%
These ratios fall within the FHA’s guidelines.
Compensating Factors for a High DTI
Sometimes, borrowers have a higher DTI than the FHA would like. This doesn’t mean an automatic denial of the loan, though. If you have compensating factors, the lender may be able to push the loan through. Compensating factors include:
- High credit score – The FHA minimum credit score is 580. A higher score, such as in the 700s could show a lender that you are responsible. This may allow them to cut you some slack on your debt ratio.
- Assets – Having reserves on hand can help your case. This is money you have that could cover the mortgage payment if your income stopped. The more months of mortgage payments you can cover, the better your chances of approval.
- Steady employment/income – Stating at the same job for many years has its perks. Lenders look at you as more reputable because you don’t change jobs frequently. It also helps if your income steadily increases over the years.
How do You Qualify for an FHA Loan?
Aside from the DTI, the FHA has other required factors. They include:
- Minimum credit score of 580, but most lenders require a higher score
- Stable employment of at least 2 years
- No collections on your credit report
- No defaults on federal loans
- At least a 3.5% down payment or 97.5% LTV
You apply for the FHA loan with an FHA approved lender. The FHA actually doesn’t have anything to do with the loan approval. The FHA approved lender knows the guidelines. They may also add their own into the mix. The FHA then guarantees the loan after it funds if it meets their guidelines. This means they pay the bank back if you default on your loan.
Paying the FHA Mortgage Insurance
A big part of your debt ratio is the FHA mortgage insurance. You pay this premium for the life of the loan. It’s how the FHA guarantees your loan for the bank. Even though it’s lender insurance, you pay the premium.
Right now, FHA borrows pay 0.85% of the current principal balance. The insurance company calculates the premiums on an annual basis. On a $100,000 loan, you’d pay $70 per month. In year 2, this amount would decrease slightly based on the average outstanding balance of your loan. You continue to pay until the loan is paid off.
The FHA max DTI requirements are more flexible than most other loan programs. If you don’t qualify for conventional financing, the FHA loan is a great alternative. It allows low down payments and flexible requirements. It’s no longer just a first-time homebuyer’s loan – anyone can apply!