New mortgage rules taking effect in 2014 will set the bar for allowable debt ratios. These rules will apply to FHA and conventional loans alike, though in different ways and at different times. In short, many borrowers with debt-to-income ratios above 43% will be shut out of the mortgage market. Here’s what you need to know.
Definition: The debt-to-income ratio (DTI) compares the amount of money a person earns to the amount he or she spends on recurring debts. For example, if I spend half of my monthly income on my various debts, I have at DTI ratio of 50%. My combined debts eat up half of my income.
These ratios have always been an important part of the mortgage qualification process. For years, lenders have had their own internal guidelines land cutoff points for debt ratios. But it’s about to become standardized across the industry.
FHA Caps Debt Ratio at 43% for Certain Borrowers
FHA loans are incredibly popular these days. The FHA’s market share peaked in 2009. Back then, credit was tight for conventional mortgage loans. So many home buyers had little choice but to use the FHA program, with its easier qualification criteria.
But a new rule announced by HUD recently could make FHA loans harder to obtain in 2014. The new rule has to do with credit scores and debt-to-income ratios. In short, borrowers with scores below 620 will have their debt ratios capped at 43%. Ratios above that level could result in disqualification of a mortgage application. If a mortgage applicant has a credit score below 620, and DTI ratio above 43%, it will send up a red flag in the FHA’s automated underwriting system (TOTAL Scorecard). At that time, the lender must manually review the applicant’s file to see if there are any offsetting factors. Borrowers who fall into this range may have a hard time qualifying for FHA loans.
Consumer Financial Protection Bureau (CFPB) announced a new set of mortgage rules. Collectively, these rules are known as the qualified mortgage, or QM. They are scheduled to take effect in 2014. In short, a qualified mortgage is a home loan that meets certain criteria designed to minimize risk. The debt-to-income ratio is one of those criteria.
According to CFPB, QM loans “generally will be provided to people who have debt-to-income ratios less than or equal to 43%. This cap on debt insured consumers are only getting what they can likely afford.”
The federal government is drawing the line at 43%, and this will trickle down to the primary mortgage market where loans are made.
Borrowers are Not Powerless. Here’s the bottom line to all of this. Borrowers who are planning to apply for a mortgage in 2014 need to review their debt –to-income ratios. The FHA rule for DTI ratios is already taking affect. The qualified mortgage rule will take effect in 2014.
What does this mean to you as a borrower? It means you need to see where you stand right now, before applying for a loan. And the sooner the better! If your total DTI ratio is above
43%, you’re in the “red zone.”
If your ratio if much higher than 43%, you should work on lowering it. There are two ways to bring that number down. You can either increase your income or reduce your debt. For most people, the second option is more realistic. If it were so easy to elevate your income, you would have done it by now!
Make a conscientious effort to pay down your debts, starting with those high-interest credit cards. You’ll sleep better at night, and you’ll have an easier time getting a mortgage loan when the time comes. If you are considering buying a home, now is the time to do it!
Kathy Henne is a RE/MAX realtor, she can be reached at (937) 778-3961 or visit www.KathyHenneTeam.com for more information.