# Debt to income ratio for the First Time Home Buyer

## Debt to income ratio explanation

The amount of money that you can borrow depends on your credit
score, loan program, and the monthly debt that you are paying each month.
The debt to income ratio is a simple formula that compares how much
monthly income you earn against your monthly obligations.

There are two calculations. The payment calculation and the debt calculation.
The payment calculation is the maximum mortgage payment if the applicant
has little or no monthly debt. The payment calculation includes principal
and interest, 1/12 of the real estate taxes, 1/12 of the homeowner's
insurance premium, private mortgage insurance (or MIP), and any other
required monthly obligations (i.e. homeowner's association fee, etc.).

The debt calculation, called the back-end ratio is the maximum amount
of monthly debt, including the proposed mortgage payment that the applicant
is permitted to carry for the loan program.

Here's the calculation:

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% |

## Debt to income ratio for an FHA loan

The
Federal Housing Administration uses the applicant's credit score to
determine the debt ratio percentage for the monthly payment and monthly
debt. For credit scores of 580 and greater, the "ideal" payment is 31%
of the applicant's monthly income and 43% for the monthly debt and proposed
mortgage payment. As you can see from the chart below, the FHA will
allow a debt ratio as high as 40% for the payment and 50% for the debt
ratio, with compensating factors. Learn more
about FHA financing

## Debt to income ratio for a VA loan

The
Veteran's Administration approaches the debt to income ratio a bit differently
from the FHA, USDA, and conventional loan lenders.

The VA only uses the back-end or debt ratio as the initial qualification
for a VA home-loan. The VA believes the "ideal" debt ratio should be
41%. That means that the monthly loan payment without any debt should
not exceed 41%, or, the proposed mortgage payment with monthly debt
should be limited to 41% of the borrower's gross monthly income.

The Veteran's Administration requires one more calculation to determine
the maximum loan amount, the calculation is called
residual income. The VA believes that the veteran should have enough
money at the end of the month to pay for food, utilities, child support,
and other expenses. The residue income analysis is actually more important
to the Veteran's Administration than the 41% debt ratio.

Learn more about VA financing

## Debt to income ratio for a USDA loan

The
USDA usually follows the FHA underwriting (approval) guidelines, however,
the USDA departs from the FHA when it comes to the debt to income ratio.
The USDA prefers a 29% payment percentage and a debt ratio of 41%. The
USDA will permit higher ratio with tight limits.

Learn more about USDA financing

## The conventional loan debt to income ratio limits

The
conventional home-loans are mortgages that meet the lending guidelines
of the Federal National Mortgage Association (Fannie Mae) and the Federal
home-loan Mortgage Corporation (Freddie Mac). The conventional loans
are not backed by the federal government and do not require any upfront
mortgage insurance. These loans do require mortgage insurance when the
purchase has a down payment less than 20% or if the loan is to refinance
an existing mortgage, the equity must be at least 20% to avoid the private
mortgage insurance cost.

The conventional debt to income limits the payment ratio to 31% and
will permit the debt ratio to extend to 45% if the borrower meets the
credit score and cash reserve requirements.

Learn more about conventional financing

## Determining your monthly income

The lender uses different approaches to determine the applicant's monthly income. The most common way of determining monthly income is the year to date income calculation. The YTD income calculator will estimate your monthly income. The calculator can add up your monthly debt payments. See the year to date income calculator

### Frequently Asked Questions About Debt To Income

**Q. What affects the debt to income the most?**

A. Without a doubt, your credit score has the greatest influence on
your debt-to-income ratio. Credit scores are used by lenders to
calculate your interest rate.

That may not seem fair, especially if your credit score has suffered
as a result of a divorce or an unethical creditor, but this is the
world we live in. A higher interest rate implies a larger monthly
mortgage payment. The private mortgage insurance premium (PMI) for
traditional mortgages is also affected by credit score.

PMI rises when the credit score falls.

Credit scores are not used by the FHA or USDA to determine monthly
mortgage insurance costs. There are no private or monthly mortgage
insurance fees with the VA loan program.

**Q. How can I improve my debt to income ratio?**

A. The first step to improve your debt to income ratio is to raise your
credit score. It might mean delaying your purchase or refinance, but
strengthening your credit may be the right decision in the long run.
Catching up on past-due bills, paying off collection accounts and judgments,
keeping your credit card balances at 50% or less than the credit limit
can lift your credit score.

Another option is adding a co-signer. Co-signers work well with the
FHA program. The FHA adds up your monthly income and debt and the
co-signer(s) income and debt to calculate the debt to income ratio.
Co-signers are not as effective with conventional loans and the VA
only recognizes spouses for maximum eligibility. The USDA requires
that the co-signer is an occupant of the home.

**Consider debt consolidation**

Debt consolidation may actually decrease your credit score for a short period of time, but, by lowering your overall monthly obligations you can give your ratio a boost.

**Q. Cut the number of payments left to pay**

A. The mortgage rules permit the underwriter (approval person) to overlook
loan balances with less than 10 payments left on a loan. Use the
YTD income and debt calculator
to help determine the pay down cost.