Debt Ratios for Home Lending

So let's talk...(Yes, that's me!)
Lenders use qualifying ratios sometimes called "debt to income ratio" to determine the most amount of money you can pay monthly with your new house payment and your other recurring debts.  As in all forms of life these days, making exceptions to rules has become the norm, so keep up with me on this topic. 

About the debt qualifying ratio

Usually, underwriting for conventional loans requires a qualifying ratio of 28/36, and can be stretched with compensating factors.  FHA loans are less strict, requiring a 29/41 ratio, and can be stretched as well with compensating factors.  Knowing the exceptions to the rules is the key here. 

The first number (front end ratio) in a qualifying ratio (28 for conventional or 29 for FHA) is the maximum percentage of your gross monthly income (before taxes are taken out) that can be applied to just your housing costs (including loan principal and interest, Private Mortgage Insurance (PMI), homeowner's insurance, flood insurance (if applicable) property tax, and homeowner or condo association dues).

The second number (back end ratio) in the ratio (36 for conventional and 41 for FHA) is the maximum percentage of your gross monthly income that can be applied to housing costs and your recurring debt.  For purposes of this ratio, debt includes payments on principal, interest, taxes, homeowners insurance, flood insurance, homeowners association dues, condominium association dues, AND credit card payments, any installment debts, student loans, auto payments, alimony, child support. 

Example:

28/36 (Conventional) qualifying ratio

• Gross monthly income of $2,700 x .28 = $756 can be applied to housing
• Gross monthly income of $2,700 x .36 = $972 can be applied to recurring debt plus housing expenses.  (That's a total of $216 for all recurring debt beyond the house payment.)

29/41 (FHA) qualifying ratio

• Gross monthly income of $2,700 x .29 = $783 can be applied to housing
• Gross monthly income of $2,700 x .41 = $1,107 can be applied to recurring debt plus housing expenses.  (That's a total of $324 for all recurring debt beyond the house payment.)

If you want to run your own numbers, please use this Mortgage Loan Pre-Qualification Calculator.

With that being said, there are ways to increase qualifying ratios for loans.  Certain compensating factors are taken into consideration when analyzing a loan application for various programs.  These are:

The ability to save money each month.
Having several months mortgage payments in the bank at closing (called reserves).
Length of time you have lived at your current residence - 24 months.
Length of time at the same place of employment. 
Making a larger down payment than required.
Rent or mortgage history shows you manage a larger payment already.
Borrower receives additional income that cannot be used in qualifying (part time income <2 yrs.).

I have been able to obtain much higher back end ratios, depending on the loan program and compensating factors up to 50%.  So, do not take these figures as an absolute fact, but realize that this is even more reason to contact me so I can see the whole picture!  It's what you don't know that can bite you! 

Here's a little tip to help you with planning.  Your monthly income spending formula should be as follows:

10% - SAVINGS (You are supposed to put this in the savings account first!)
35% - HOUSING & REPAIRS
15% - INSTALLMENT & CREDIT CARDS
15% - TRANSPORTATION
25% - EVERYTHING ELSE
______

100% - OF GROSS INCOME, NOT NET INCOME (your take home pay)!  (Underwriting guidelines are written with the illusions that the tax deductions from your pay check are somehow something you can tangibly spend.  All the more reason to have a prepared budget and not rely on these ratios!)

Speaking of budgets, the lending guidelines do not take into consideration any of the following items, when preparing your loan approval, but you should - these are the "25% - Everything Else" category above:

Savings and Retirement Planning
Auto Insurance

Auto Repairs

Auto Registration

Auto Driver’s License

Auto Gasoline

Cell Phone Payments

Church and Charities

Clothing

Computer

Day Care

Dental Bills

Dinners Out

Doctor Bills

Education Costs

Elder Costs

Electric

Emergency Funds

Entertainment

Eye Exams/Costs

Fitness Center

Furniture

Gifts

Groceries

Hair Cuts

Holiday Costs

Home Improvements

Home Maintenance

Home Repairs

Laundry & Dry Cleaning

License Renewals – Professional & Unions

Life Insurance

Lunches

Insurance – Dental

Insurance – Eye

Insurance – Medical

Magazines

Miscellaneous - Household

Manicure / Pedicure

Newspaper

Pest Control

Pool Supplies

Pool Repairs

Postage

Prescriptions

Printer Costs & Ink

Software

Starbucks

Tax Preparation Costs

Telephone

Travel

Utilities – Gas, Electric, Water, Sewer

Vacations

Vet Costs

So...go through your bank statement and put together a budget of where you are now spending your money.  Then determine how you can reduce your spending over the next few months.