FHA Debt Ratios are Not Always Set in Stone

Reader Question: “I have heard that mortgage lenders have gotten really strict over the last couple of years with debt ratios on FHA loans. Is this true? If so, what is the maximum allowable debt-to-income ratio for first-time home buyers in 2012? And do they use gross or net income when calculating these numbers? Any clarification would be much appreciated.”

Brandon’s Response: Lenders are more strict about everything these days. That goes for credit scores, debt limits, document verification, etc. But I haven’t heard about any special scrutiny being given to debt-to-income ratios.

Later, I’ll explain the general “rules” for debt-to-income ratios on FHA loans. But first I want to clear up some terminology for other readers who aren’t savvy on this topic. Here are some helpful definitions:

  • An FHA loan is a mortgage loan made in the primary mortgage market but insured by the federal government. This program is managed by the Department of Housing and Urban Development (HUD).
  • Your debt-to-income ratio is a comparison between the amount of money you earn each month, and the amount you spend on your various debts (including your mortgage payment, in some cases). It is also referred to as your DTI, for short. You have two of these ratios. The front-end ratio only looks at your housing-related debt. Your back-end ratio takes all of your combined debts into account, including car payments, credit cards, etc.

To answer one of your questions, lenders typically use your gross monthly income to calculate your DTI ratios. This is the amount you earn before taxes are taken out, as opposed to your take-home pay. This is an important distinction for FHA loan qualification. So if you are trying to calculate your own debt-to-income numbers, be sure to use your gross income.

Another important point: These rules apply to all home buyers, not just the first-time buyers. This program does not make any distinction between first-timers and repeat buyers.

We Asked 27 Mortgage Lenders About This…

Earlier this month, we surveyed a group of 27 mortgage lenders of various sizes, located all throughout the United States. We asked them what kind of guidelines they would be using for FHA loans in 2012. Debt-to-income ratio was one of the topics of inquiry. If you haven’t done so already, you should read the results of that survey.

FHA Loan Guidelines

Some lenders said they’ve been approving borrowers with back-end DTI ratios as high as 52%. As long as the person was otherwise qualified for the loan, they could still be approved by the automated underwriting system.

Other lenders set the bar at 43% DTI. Borrowers who were using more than 43% of their gross monthly income to cover their total debts (including housing costs) would likely fall short of these lenders’ requirements. Just remember that some banks are willing to work with borrowers above this mark.

Debt Ratios Vary from Lender to Lender

The maximum debt-to-income ratio for an FHA loan will largely depend on which lender you use. It will also come down to how well you measure up in other areas, such as your credit score. The size of your down payment also plays a major role in all of this. The larger your down payment, the less risk there is for the lender. On the contrary, a smaller down payment exposes the lender to more risk (investment) in the deal. How flexible they are with their DTI ratios will often come down to how much risk they carry.

As you can see, this is not something that is set in stone. There are exceptions to almost every rule when it comes to FHA loans, and the debt-to-income ratio is a prime example of this. The only way to find out for sure if you can qualify is to apply for a loan. Every borrower reaches this point eventually. You do your homework. You research the different types of loans. You check your credit score and examine your debt situation. But the only way to find out if you are truly qualified is to take the next step. You have to apply for the program through an FHA-approved lender. You can find one using the HUD website (www.hud.gov).

Pre-Approval vs. Final Loan Approval

You might receive an initial approval from a lender, which is referred to as pre-approval. And then later, you may receive an email from your loan officer with a list of conditions that must be met, before you can get a final approval. This is a common scenario. One of those conditions might have to do with your debt-to-income ratio.

For example, the loan officer might tell you that you’ll need to pay off a certain credit card balance, in order to be approved. Or they might approve you with your DTI ratio as is, with no additional “hoops” to jump through. Just know that this is a possibility. If your lender gives you one of these conditions to meet, it’s because you currently fall outside of their FHA debt-to-income guidelines.

At this point, you have two choices. You can try to satisfy the the condition they’ve set before you. Or, if that’s not possible for some reason, you can try to find another lender. Remember what I said earlier, about debt requirements and how they vary from one mortgage lender to the next. It’s common to have one “door” shut in your face, only to find a side door a few days later. It happens all the time.

Disclaimer: This article explains the basic requirements for debt-to-income ratios on FHA loans. Please note that these requirements are not set in stone. This article is provided for educational purposes only. You should not view this information as the final word on this subject. The only way to find out if you qualify for an FHA loan is to apply for one.