Your debt-to-income (DTI) ratio is one of the main factors that determines whether or not you are eligible for an FHA home loan.
But don’t worry if you’ve never heard of a debt-to-income ratio before. Most people don’t learn about DTI until they’re preparing to get a loan for something like a car or home.
It’s important to be aware of lender debt-to-income requirements when applying for an FHA loan to increase the chance of loan approval. In addition, it is highly recommended to calculate your DTI ratio to see where you stand.
What is the FHA Debt-to-Income Ratio?
Your debt-to-income (DTI) ratio is simply how much of your income goes toward debt payments every month. Lenders need to know you’ll have enough money coming in every month to make all your debt payments (including your new home loan) and still have money left over to cover your normal living expenses. This reduces the risk that you will default on your loan, leaving the lender exposed.
While every lender is different, most lenders want to see your DTI ratio at 43% or below.
A debt-to-income ratio is usually broken into two categories for an FHA loan: front-end and back-end.
FHA Front-End DTI
Front-end DTI only looks at the monthly housing expenses for your future home. This means that your front-end DTI only factors in:
- Principal and interest on your loan
- Property taxes
- Homeowner’s insurance premiums
- Any homeowner’s association (HOA) dues
Lenders typically look for a front-end DTI of 31% or less.
FHA Back-End DTI
Back-end DTI considers all consumer debts listed on your credit report, in addition to the housing expenses used for the front-end DTI. These consumer debts include:
- Credit card debt
- Student loans
- Auto loans
- Personal loans
- Medical loans
Lenders typically look for a back-end DTI of 43% or less.
Back-end DTI is more useful to lenders because it provides a more complete picture of your financial obligations. Back-end DTI is the default, so if you hear someone refer to a debt-to-income ratio without “front-end” or “back-end,” you can usually assume they are referring to the back-end DTI.
How to Calculate DTI Ratio for FHA Loans
Calculating your debt-to-income ratio may seem overwhelming and time-consuming. However, you can calculate your DTI for an FHA loan in three simple steps.
Step 1: Total Your Monthly Debt Payments
For the front-end DTI, add up your future housing expenses:
- Principal and interest on your loan
- Property taxes
- Homeowner’s insurance premiums
- Any homeowner’s association (HOA) dues
For the back-end DTI, add all other monthly debt payments to your future housing expenses, including:
- Credit card debt
- Student loans
- Auto loans
- Personal loans
- Medical loans
Step 2: Divide the Total Debt Payment Amount by Your Gross Monthly Income
Your gross monthly income is the amount you earn before taxes are taken out. Make sure you’re using your monthly income (if you’re paid twice per month, for example, you’ll need to add up two pay stubs).
Step 3: Multiply This Amount by 100
Multiplying that amount by 100 will convert the value to a percentage, and give your debt-to-income ratio.
Sample Front-End DTI Calculation
To calculate your front-end ratio, use the following formula:
Total monthly housing expenses / monthly pre-tax income x 100 = front-end DTI
Here is an example of a front-end DTI ratio calculation:
$1,500 monthly housing expenses divided by $5,000 gross monthly income times 100 = a 30% front-end DTI
Sample Back-End DTI Calculation
To calculate your back-end ratio, use the following formula:
(Total monthly housing expenses + total monthly consumer debt payments) / monthly pre-tax income x 100 = back-end DTI
Here is an example of a back-end DTI ratio calculation:
$1,500 monthly housing expenses plus $600 monthly consumer debts divided by $5,000 gross monthly income times 100 = a 42% back-end DTI
How to Lower DTI Ratio for FHA Loan
If your DTI is higher than the 43% maximum DTI for FHA loans, there are a few things you can do to lower the ratio:
- Increase your income: This doesn’t mean you have to get a new job, but starting a side hustle or negotiating a raise at work can greatly affect your DTI.
- Pay off small debts: If you can afford to pay off a debt in full, you’ll remove that monthly debt payment from your DTI calculation, which will lower your DTI.
Get a co-borrower: Having another person on your loan could lower your DTI because it can add that person’s income to your DTI calculation. Keep in mind, you would also have to add their debts to your calculation.
FHA Loan DTI Ratio Compensating Factors
If you can’t get your DTI under 43%, you might still be able to qualify for an FHA loan if you’re especially strong in other areas. FHA DTI requirements leave a little wiggle room for borrowers who offset the greater risk of a high DTI ratio by meeting certain compensating factors, including:
- An excellent credit score: A credit score over 740 could allow you a higher DTI.
- A large down payment: The more you put down on a house, the less risk the lender is taking.
- Cash reserves: Having at least three months’ worth of mortgage payments in your savings account could offer extra assurance for your lender.
- Steady employment: If you’ve been with the same employer for a long time, and there is no indication that the company, or your position at the company, is in jeopardy, lenders might feel more comfortable loaning you money.
- Minimal payment shock: If your housing expenses will be similar to what you’re used to paying in rent each month, lenders can be more confident in your ability to make your mortgage payments.
Your FHA debt-to-income ratio may be an important factor in determining whether you qualify for an FHA loan, but it isn’t the only factor. Lenders just want as much assurance as possible that you will be able to make your mortgage payments consistently.
