How USDA Loans Calculate Debt-to-Income Ratios

Calculate how much you can borrow for a USDA loan.

Balance scale Lenders use your debt-to-income ratio (DTI) to determine how much money you can borrow for a mortgage. The USDA has strict guidelines when it comes to debt to income ratios.

In order to qualify for a USDA loan, your debt to income ratio for your monthly payment must be 29% or less. The back-end ratio is also called the debt ratio, which is the total amount of monthly debt paid each month. The back end ratio also includes the new mortgage payment.

You divide the mortgage payment by the gross annual income to arrive at the front-end debt ratio. The only solution to a high debt ratio is to reduce or payoff debt and or lower the anticipated mortgage payment to get the back-end debt ratio below 41%.
For example, if your monthly housing expenses are $1,500 and your monthly gross income is $6,000, your DTI would be 25 percent.

Most lenders prefer a DTI of 41 percent or less, but some lenders may allow a DTI up to 45 percent.

Your DTI includes your housing expenses, plus any other monthly debt payments. This includes car payments, student loans, and credit card payments.

Your DTI also includes monthly housing expenses for all borrowers on the loan. This includes monthly mortgage payments, homeowners insurance, and property taxes.

If you have a lot of debt, you may not be able to qualify for a mortgage. You can work to reduce your DTI by paying off debt or by refinancing your mortgage to a lower interest rate.

If you’re having trouble qualifying for a mortgage because of your DTI, you may want to consider a government-backed loan. Government-backed loans have more lenient DTI requirements.

A USDA loan is a government-backed loan that is available to borrowers with low- to moderate-income. To qualify for a USDA loan, your DTI cannot exceed 45 percent.

USDA Debt to Income Ratio Guidelines

The USDA has strict guidelines when it comes to debt to income ratios. In order to qualify for a USDA loan, your debt to income ratio must be less than 29%.

This means that your total monthly debt payments (including the mortgage payment) cannot exceed 29% of your monthly income.

There are a few factors that can affect your DTI, including:

The size of your down payment
The term of your mortgage
The interest rate on your mortgage
The type of mortgage you choose
Your credit score

Your debt-to-income ratio is just one factor that a lender considers when you apply for a mortgage.

To get the best mortgage rate and terms, you’ll want to make sure your credit score is in good shape and that your monthly debt payments don’t exceed 43% of your monthly income.

Just how much house can you afford? The answer lies in your debt to income ratio.

There are two DTI calculations, the payment ratio often called the front-end ratio and the second calculation take into consideration the proposed mortgage payments along with monthly debt obligations. For example:

Front-end ratio (29%)	Back-end ratio (41%)
Principal & Interest 1/12 of annual property taxes 1/12 of the annual home owner's insurance 1/12 of the annual mortgage insurance premium	Car payment Child or spousal support payment Co-signed loans, unless you have 12 months of proof you are not paying the loan Collections payments or other judgments Credit card payment Installment payment Personal loan payment PITI (or total housing payment) Student loan payment

How to Calculate the Debt to Income Ratio for a USDA Loan?

The debt to income calculation is simple enough. You divide the mortgage payment by the gross annual income to arrive at the front-end debt ratio. Here's an example:

USDA Front End Ratio

Loan payment - $1,000 divided by the gross monthly income. In this example, we'll assume the monthly income is $5,000. Dividing $1,000 by $5,000 equals 20%. Perfect! 20% is less than 29%.

USDA Back End Ratio

Now we'll take a look at the back-end ratio. The back-end ratio is also called the debt ratio. This calculation includes the proposed mortgage payment (principal and interest, 1/12 of the real estate taxes and homeowner's insurance, and mortgage insurance premium if applicable), plus monthly debts.

Let's assume the monthly payment and all of the reoccurring monthly debts total $2,000. Divide $2,000 by the monthly income of $5,000 and you have a back-end ratio of 40%.

But what if the monthly debt totals $2,000? Take the mortgage payment + monthly debt ($3,000) and divide the total by $5,000. $3,000/$5,000 = 60%. Whoa! A 60% debt ratio is much greater than the USDA guideline of 41%. The only solution to a high debt ratio is to reduce or payoff debt and or lower the anticipated mortgage payment to get the back-end debt ratio below 41%.

Ten month exemption

Most debt obligation are not required to be brought into the debt calculation if the remaining debt balance is less than 10 months. Here's what the USDA manual has to say about debt lasting ten months:

"Provided the credit report, creditor verification, or other evidence indicates that ten or less months of repayment remain, the monthly debt may be ignored if the payment does not exceed five percent of the monthly repayment income."

"Installment debt may be paid down to a balance of 10 months or less."

It should be noted that the underwriter has the final say on ignoring debts with less than 10 months. If he or she believes the remaining debt payments represent a financial hardship, the underwriter may let the short number of payments remain, which in turn will increase your back end ratio. Ouch!

The USDA provides a clear understanding of debt obligation.
>USDA underwriting manual

Conclusion

In conclusion, it is important to be aware of the USDA Debt to Income Ratio Guidelines when considering a home loan. Knowing these guidelines can help you determine whether you are likely to qualify for a USDA loan and what size of loan you may be eligible for. If you have any questions, be sure to consult with a mortgage lender or housing counselor.

SOURCE: USDA Chapter 11: Ratio Analyis