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When purchasing a new home, homebuyers may feel overwhelmed by the variety of financial aspects to consider. One aspect they might need to become more familiar with is their debt-to-income (DTI) ratio. This percentage shows how much of a borrower's paycheck goes towards paying debts every month.
A borrower's DTI ratio is highly significant to lenders. A high DTI implies that a substantial chunk of your income is already devoted to debts, making lenders hesitant about your ability to cope with additional monthly loan payments. Lenders want to ensure you will have enough money to pay for your other living expenses if you take on the cost of a new USDA loan.
Understanding your DTI ratio is key when applying for a USDA loan. Let's dive deeper into USDA DTI limits and requirements.
What is the DTI limit for USDA loans?
The borrower's proposed monthly housing expenses (top ratio) for USDA loans may not exceed 29% of their repayment income. Additionally, their overall monthly debts may not surpass 41% of their repayment income.
USDA DTI Requirements
There are two ratios that lenders will consider when looking at the makeup and total amount of your debts: the top and bottom ratios. If either ratio exceeds max USDA DTI limits, you may not be approved for a USDA loan.
Conversely, you can have too much monthly income, as USDA loans have income limits. USDA loan borrowers cannot have an income higher than 115% of the median household income in their area.
The Top Ratio
Also known as the front-end or PITI ratio, the top ratio measures your total monthly housing debt against your gross monthly income.
The PITI represents:
- Principal: The loan amount you repay each month.
- Interest: The cost of borrowing.
- Taxes: Real estate taxes.
- Insurance: Includes homeowners insurance and potentially other types, such as natural disaster coverage.
Other potential components of your PITI might be HOA fees, condo charges or special assessments. Your total PITI amount can be found on your mortgage statement every month.
The Bottom Ratio
Often referred to as the back-end or total debt ratio, this represents your significant monthly financial obligations relative to your gross income, including:
- Your complete housing payment
- Payments for personal loans, credit cards, vehicles and student loans
- Child or spousal support
- Payments towards collections or other judgments
However, some monthly expenses, like phone bills or health insurance, aren't considered.
USDA DTI Compensating Factors
If your DTI ratios exceed the standard 29/41 thresholds, there are compensating factors that might make up for your higher debt levels and sway lenders to approve your application. These can range from consistent employment history to significant savings.
With strong compensating factors, borrowers can request a debt ratio waiver, potentially allowing them to secure a loan even with DTI ratios that slightly exceed the typical requirements.
How to Calculate Your USDA DTI Ratio
To calculate your DTI, first calculate your monthly gross income. You can do this by determining your annual pre-tax earnings and dividing by 12 or by checking your last month's pay stub. Make sure to use the pre-tax amount before deductions like healthcare or retirement.
When you've found your monthly gross income, you can calculate your PITI ratio or overall debt-to-income ratio by dividing your debt by your monthly gross income and multiplying by 100. Once both are calculated, the two DTI ratios are often written as "housing debt ratio/overall DTI" or "29/42."
The Bottom Line
If you're aiming to secure a USDA loan, understanding and calculating your DTI ratio is vital. Consult a USDA loan specialist here at Neighbors Bank to clarify any queries or doubts. They're equipped to comprehensively review your finances and guide you on your path to homeownership.