The ABCs of DTIs – Debt-to-Income Ratios
Definition of Debt-to-Income Ratio: The figure that represents how much of your income is spent repaying your recurring monthly debts. The HIGHER your Debt-to-Income Ratio is, the more of your monthly income is being devoted to paying back your debts.
Formula Used to Find Your Debt-to-Income Ratio: Monthly debts owed divided by monthly income. This includes utilizing ALL Recurring Monthly Debt VS Gross Monthly Income, as determined ultimately by an Underwriter at Final Approval.
While those factors are definitely important, there are two additional factors that I often see overlooked. Those are:
- Debt-to-Income Ratio
- Property Taxes
My findings are backed-up by those in a new survey provided by FICO. This survey reveals that Debt-to-Income Ratios are the #1 factor contributing to denial for loan. 60% of credit-risk managers surveyed by FICO considered Debt-to-Income Ratios as their #1 concern.
Debt-to-Income Ratios represent an excellent example of WHY I encourage all hopeful homebuyers to contact a Mortgage Lender well in advance of the time they hope to purchase. If given time to do so, they can help the borrower successfully improve (Lower) their DTI ratios.
It’s important to know: Even small improvements can mean the difference between loan denial and a successful Approval.
So, what IS an acceptable Debt-to-Income Ratio?
Here are the ABC’s of DTIs:
Defining “acceptable” can be somewhat hard these days, but typically, with the implementation of the new “Ability to Repay and Qualified Mortgage Rule“ on January 10, 2014, acceptable ratios are defined: As high as *43%.
* Now that said, currently there are exceptions to this Rule. Exceptions that allow for up to 45% DTIs, as well as up to 50% +/- on FHA Loans. Final determinations of “acceptability” are made on a case-by-case basis, land can be impacted by the other layers of risk (down payment, credit scores, job history, reserves).
All this talk of “acceptability” and “exceptions-to-the-rule” leads me to always advise that:
Anyone hoping to buy a home contact a lender sooner than later. That way, if improvements are needed to your Debt-to-Income Ratio or credit, etc., you can address those issues together and make improvements as quickly as possible.
The other factor I see contributing to loan denials surrounds Property Taxes. In fact, for my borrowers, it’s the reason I see come into play most often.
As a result, even in preliminary conversations with my clients, the following questions are always included:
- Do you already have a specific property in mind for purchase?
- What are Property Taxes for that home?
- Are their Assessments involved?
- Does the property have HOA fees?
In short, if your DTIs are close to being maxed-out, the Property Taxes on the home you’re considering for purchase can cause you to exceed Debt-to-Income Ratios. That’s not good.
When this happens, my borrowers typically choose to resolve the issue by starting another property search. This time they consider only those homes with lower property taxes, no/lower Assessments, or no HOA fees. In other words, the homes they can qualify for.
For those hoping to buy a home, the process can seem a bit daunting. It shouldn’t … and it doesn’t have to be. Debt-to-Income Ratios can be addressed properly UPFRONT, with the right guidance and time.