The amount of income you use to pay a mortgage is important in determining whether you'll repay the loan. Congress created the Federal Housing Administration to minimize the risk involved with financing low-income borrowers. As an agency within the Department of Housing and Urban Development, the FHA insures lenders against default. HUD sets flexible guidelines for the amount of debt a borrower can have relative to his income, known as debt-to-income ratios.
There are two types of Debt-to-Income Ratios that lenders consider when approving you for a loan. DTIs are expressed as percentages. The housing ratio -- also known as the front-end ratio -- compares your monthly housing payment of principal, interest, taxes and insurance to your gross income. The back-end ratio compares your total recurring debt and housing payment to your income. The federal guidelines for mortgage DTI ratios are outlined in the HUD Handbook for FHA loans.
A healthy back-end DTI ratio is 36 percent or less, Bankrate says. Conventional loans generally come with a 28 percent front-end DTI requirement, according to the Federal Reserve Board. The FHA has benchmark guidelines of 31 percent front-end and 43 percent back-end ratios. HUD may revise its guidelines according to its risk-management needs. It also offers additional flexibility for certain programs. For example, the front-end ratio is set at 33 percent for the FHA’s Energy Efficient Homes program, which insures loans for energy-efficient improvements.
Federal guidelines allow a borrower to exceed benchmark DTI ratios when certain compensating factors exist. You have to provide documentation that supports your ability to afford a higher-than-usual payment. Acceptable compensating factors include a previous housing payment that is higher than, equal to or minimally lower than the new housing payment. You must have a good track record of making the housing payments on time for one to two years. A large down payment of 10 percent or more and accumulated savings are also compensating factors which allow for a higher DTI ratio.
If you owe more on a conventional home loan than your property is worth, you can refinance using an FHA-insured loan. The FHA Refinance of Borrowers in Negative Equity Positions is even more flexible than other FHA loans. You can qualify with as much as a 35 percent housing DTI ratio and a back-end ratio of 48 percent, according to HUD. The increased DTI ratios apply to refinances beginning in March 2012 and completed by December 31, 2014.
- Bankrate: Debt-to-Income Ratio Calculator
- Federal Reserve Board: The Mortgage Application Process
- FHA: Debt Ratios
- HUD: Mortgagee Letter 2012-05: FHA Refinance of Borrowers in Negative Equity Positions: Program Enhancements
- HUD: Federal Housing Administration
- HUD: Handbook 4155.1: Chapter 4, Section F: Qualifying Ratios
- HUD: Handbook 4155.1: Chapter 4, Section F: Compensating Factors
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