Balancing debt when seeking an FHA loan
Q: We want FHA financing. Our loan officer says we may be able to get preapproved even though our monthly debts equal 52% of our income. Isn’t 52% too high?
A: Under FHA guidelines, it’s possible in some circumstances to have a monthly debt-to-income ratio (DTI) of as much as 56.9%. Not a good idea, but possible.
One of the major underwriting considerations for any loan program is the DTI. Loan programs typically limit monthly debts to reduce lender risk. For example, with the FHA program, the basic DTI ratios are 31/43.
The 31% “front” DTI ratio compares monthly housing debt with gross monthly income. The housing debt includes at least mortgage principal, mortgage interest, property taxes and property insurance — what’s known as PITI.
The 43% “back” DTI ratio includes housing debt plus recurring monthly costs for such things as auto financing, credit cards and student loans.
You can, however, get FHA financing with higher DTI ratios. In fiscal year 2020 — the period ending in September 2020 — HUD reported that 24.53% of the loans insured through the FHA program had back DTI ratios above 50%.
How does this happen? Excess DTI ratios can be allowed if the borrower has certain offsetting factors.
Additional reserves: The FHA program — like virtually all loan programs — loves borrowers with an ability to save. Savings offset the risk. If there’s a job loss or reduced income, the borrower has time to get a new job without missing a mortgage payment. For properties with one to two units, HUD wants to see reserves equal to three monthly payments.
Energy efficiency: HUD allows ratios up to 33/45 for energy-efficient homes, under the theory that lower utility bills offset higher monthly mortgage costs.
High credit scores: Lenders want to know that you have a solid income, but that’s not enough. Someone with a good income who does not pay their bills is a substantial risk. Borrowers with high credit scores have evidence of their commitment to pay monthly debts, something lenders appreciate.
Steady payment:
HUD will be very happy if monthly housing costs stay the same, are lower or increase no more than $100 or 5%.
Residual income: The FHA program wants to make certain that borrowers are not impoverished by their mortgage financing. Toward this end, residual income — the amount of money you have each month after various expenses — can be a compensating factor. Residual income requirements vary by location and household size.
As a borrower, you’re ahead if you can show that you qualify for a compensating factor. You’re doing better still if you can qualify for several qualifying factors.
Now, about that allowable 52% DTI.
Yes, the rules may OK it, but consider some cautions.
First, many lenders will decline loan applications with supersize DTI numbers. They see such applications as simply too risky.
Second, steep monthly debts can significantly limit your lifestyle options and ability to save.
Third, what happens if you lose a job or suddenly earn less? If the pandemic, automation and job losses have taught us anything, it’s that jobs are a lot less certain than we used to believe. Less income and big monthly debts are not a good combination.
A lender might allow 52% or even more, but what’s best for you? Maybe a more comfortable option is a less expensive property, a smaller mortgage debt and better sleep.