One of the most important factors in determining the path of your mortgage process is your debt-to-income ratio. This article from Lisa Prevost, appearing in The New York Times, explains how a debt-to-income ratio is determined, and highlights some ways to reduce a ratio that’s too high.
A mortgage applicant with a high level of debt relative to income is not an appealing risk for lenders. Therefore, first-time home buyers should ensure their debt-to-income ratio is within accepted limits if they are counting on a quick approval.
A borrower’s debt-to-income ratio is one of the most critical factors in the loan review process because it helps determine an individual’s ability to repay. It is calculated by totaling the borrower’s monthly debt obligations and dividing that number by gross monthly income.
The debt figure includes monthly payments on any outstanding loans, credit card balances and child support obligations, as well as the proposed mortgage payment and associated housing expenses, such as maintenance fees, real estate taxes and property insurance. It does not include utility expenses. But if a borrower has a deferred student loan – meaning payments aren’t yet due – 1 percent of that loan balance is counted into the monthly obligation. (For loans backed by the Federal Housing Administration, the figure is 2 percent.)
The gross monthly income figure is more straightforward: This is income before taxes and other automatic deductions.
A borrower with monthly debt obligations of $3,500 and a gross monthly income of $8,500, for example, would have a debt-to-income ratio of 41 percent. That is approaching the limit of what Fannie Mae and other government agencies backing loans like to see.
Technically, a ratio of 43 percent is the ceiling for a “qualified mortgage,” as defined by the regulations put in place in 2014 requiring lenders to ensure borrowers’ ability to repay. But Fannie will approve borrowers with ratios as high as 50 percent when the higher debt is strongly compensated for by other factors, said Mark Yecies, an owner of SunQuest Funding, a brokerage in Cranford, N.J.
“You usually need 12 months of reserves to get a ratio approved over 45,” Mr. Yecies said, referring to levels of cash on hand. Other requirements might be a higher down payment, sterling credit, or both.
