Before you can qualify for a home, your mortgage lender must consider several factors. One important thing they must take into account is your debt-to-income ratio (DTI). Because of specific DTI requirements, debt often keeps borrowers from qualifying for a home loan.
Starting in July, Fannie Mae will implement changes to borrower requirements. One of the major changes will ease DTI requirements, giving more borrowers the chance to become homeowners.
How does DTI impact home buying?
DTI is the total of all of your monthly debt payments (credit cards, car payments, student loans, etc.) divided by your gross monthly income (your income before taxes and deductions.) For example, if you have a monthly income of $5,000 and your monthly debt payments are $2,100, your DTI is 42%.
Helpful hint: Your DTI is calculated using your gross income, but try basing your own calculations off of your net income, which is your income once taxes and deductions are taken out.
This will give you a more realistic view of your finances and show you what you can comfortably afford.
According to the Federal Reserve and FICO®, a borrower’s debt-to-income ratio is the number one factor lenders consider when qualifying a borrower, and is a common reason why some borrowers don’t get approved for mortgages. The lower your DTI ratio, the better. In most cases, lenders prefer a DTI of 45% or less to qualify a borrower for a mortgage. Fannie Mae, Freddie Mac, and the Federal Housing Administration (FHA) have a few exemptions that allow them to insure and buy loans with higher ratios.
Higher DTIs are especially common among millennials, many of whom graduated with student debt, have just started their careers, and are often living paycheck to paycheck. The new Fannie Mae DTI requirement changes may help those who have slightly higher DTI ratios, particularly millennials, become homeowners.
What are the debt-to-income changes?
Beginning July 29, 2017, Fannie Mae will be raising the DTI ceiling from its current maximum of 45% to a 50% maximum.
Fannie Mae regularly conducts a risk analysis to assess how it aligns with the latest information on loan performance. Their last review revealed that there were many potential homeowners whose DTIs were in this 45 to 50% range. The data revealed that a lot of these borrowers have good credit, qualify in other categories, and are not very likely to default on payments, despite their higher DTI ratio.
What does this mean for homebuyers?
Borrowers with DTI ratios over the existing 45% ceiling who had not previously been eligible for a loan may now have a chance at becoming homeowners.
“This change is going to be a big advantage to anyone who has debt, and wants to own a home,” says Bob Macomber, Vice President of Credit Risk and Analysis as Atlantic Bay Mortgage Group®. “It doesn’t have to be student loans, it can be credit cards, car payments, etc. These people may now be able to own a home.”
But this change does not mean that everyone with a 50% DTI ratio will be approved. There are other factors that lenders weigh before qualifying borrowers for mortgages. Some of these factors include credit scores and how much money a potential borrower has available for a down payment. For borrowers with higher DTI scores, these other factors will be very important considerations for the lender.
Federal Housing Administration (FHA) loans are the primary option for borrowers with higher DTIs. Debt-to-income requirements are flexible under FHA loans for borrowers under the right circumstances: having a larger down payment, assets, large amounts of savings, and/or cash revenues. Effective July 29, these borrowers will have more of a variety of loan options.
Another change coming in July: Fannie Mae is will increase the loan-to-value (LTV) ratio maximum for adjustable rate mortgages (ARMs). The current maximum is 90%, but starting July 29, the maximum LTV ratio will be 95%. ARMs are great for someone who knows they will be moving in a few years or for a borrower who knows they will be able to pay off the loan quickly.
Whether you’re a first-time buyer with a higher DTI ratio or if your DTI ratio has kept you from your dreams of homeownership in the past, this Fannie Mae change may be your key to owning a home.