Michaela Phillips,
Guaranteed Rate, Inc.
Debt-to-income ratio is crucial when qualifying for a mortgage; it’s one of the most important factors. Per the Washington Post, it’s also the number one reason applicants are turned down: their credit cards are too high and their salaries too low.
This restricts people from buying, particularly young people saddled with student debt and entry-level jobs. But this is about to change.
Fannie Mae, the Federal National Mortgage Association, is easing its requirements. Starting July 29, the debt-to-income ceiling is increasing from 45 percent to 50 percent. This might not seem like a lot, but it may be the difference between qualification and rejection.
How debt-to-income works
Debt-to-income, abbreviated DTI, is a ratio that takes your gross monthly income and compares it to your debts – credit cards, bank loans, auto loans, other mortgages and anything else outstanding. It also factors in the potential mortgage payment you’ll be predicted to make each month. If you make $5,000 a month and you have $2,500 in monthly debts, your DTI is calculated at
50 percent. Lenders use DTI to assess your ability to pay them back. If you can’t afford a loan, they don’t want to give it to you.
Fannie Mae, Freddie Mac, and the Federal Housing Administration set 43 percent as the maximum DTI qualifying someone for a mortgage. However, they have exemptions that allow them to take on borrowers with higher ratios.
Fannie Mae based their decision to increase the DTI on research that showed people with DTIs up to 50 percent didn’t often default; they were responsible home owners with good credit. Of course, just because the DTI is moving to 50 percent, not everyone in the 45 to 50 percent range will be approved.
Fannie Mae has an automated underwriting system that examines your financial standing as a complete package. It takes into consideration many factors, including the size of the down payment and job stability. It also looks at your credit score. Fannie Mae tends to be strict with credit scores, and you typically need decent numbers to qualify.
Still, Fannie Mae isn’t the only player in the game: those looking for mortgages have been able to procure them through FHA loans. These loans are more liberal with their DTI ratios and often lend to people with DTIs over 50 percent. But they come with a drawback: borrowers must pay mortgage insurance premiums for the entirety of the loan. Insurance premiums for Fannie Mae, on the other hand, are canceled once the principle balance drops to under 78 percent of the purchased value.
The revised guidelines don’t guarantee home ownership for everyone, but they’ll make a huge difference for some. They’ll open doors that would have otherwise remained shut.
By Michaela Phillips, Guaranteed Rate, Inc. Michaela Phillips is the Vice President of Mortgage Lending at Guaranteed Rate, Inc. Contact Michaela at 303.579.5517, e-mail [email protected] or visit michaelaphillips.com. NMLS:312874.
