Debt-to-income Ratio Disqualifies Buyers

There’s new insight for home buyers in understanding why they might get rejected when applying for a mortgage. In a new study from credit-score giant FICO nearly 60% of risk managers rated excessive debt-to-income ratios “DTIs” as their No. 1 concern factor.

This survey offers buyers a rare peek inside the heads of credit-risk managers at financial institutions across the country and in Canada. Researchers asked a representative sample of them what single factor in an application makes them most hesitant to fund a loan request — in other words, what’s most likely to prompt them to say no.

debt-to-income-ratio

Many new buyers have only a rough idea in advance of an application — even for a pre-approval letter — about their own DTIs, how lenders view them, and what sort of limits they’re likely to encounter.

Since they are so important to a successful application, here’s a quick overview on what goes into DTIs and why they are such a big red flag. Debt-to-income ratios for home loans are the most direct indication to a bank about whether you are going to be able to afford to repay the money you want to borrow.

As a general target, lenders like to see your housing expense ratio come in at no higher than 28% of gross monthly income, though there is flexibility to go higher if other elements of your application are viewed as strong. In May, according to mortgage software and research firm Ellie Mae, the average borrower who obtained home purchase money through investors Freddie Mac and Fannie Mae had a housing expense ratio of 22%. Federal Housing Administration-approved borrowers had average housing expense ratios of 28%.

Additionally, they look at the so-called back-end ratio which measures your income against all your recurring monthly debts. These include housing expenses, credit cards, student loans, personal loan payments and others. Under federal “qualified mortgage” standards that took effect in January, your back-end ratio maximum generally is 43%, though again there is wiggle room case by case.

Most lenders making loans eligible for sale to Fannie or Freddie prefer not to see you anywhere close to 43%. In May, according to Ellie Mae, the average approved home purchase applicant had a back-end ratio of 34%. Even at FHA, which tends to be more lenient on credit matters than Fannie or Freddie, the average back-end ratio for buyers was 41%. The average for denied applications was 47%.

A good place to learn more about DTIs and to compute your own is Fannie Mae’s consumer-friendly “know your options” site (www.knowyouroptions.com), which includes calculators and other helpful tools.

The new FICO survey found that the second leading cause of concern for loan officers is “multiple recent credit applications.” Lenders spot these on your credit reports and take them as signals that you are seeking to add on even more debt, which could affect your ability to repay the mortgage money you’re asking them to give you.

Bottom line here: If you want to be successful in your mortgage application, be aware of these key turnoff points for lenders and take steps to avoid the tripwires. Most important: Postpone your purchase until your DTI ratios tell you that yes, you can afford the house you want and lenders won’t reject you out of hand.

Do you see buyers being disqualified by their DTIs in your area? We’d like to hear from you!

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