The FHA provides low- to moderate-income people the chance to buy their own house. It does this by insuring the mortgages FHA-approved creditors supply. This allows lenders to unwind their eligibility standards and accept borrowers with lower incomes and a less than perfect credit history. On the other hand, the FHA should nevertheless affirm that debtors can afford their mortgages. One of the tools that the FHA uses to decide how much a borrower can afford is the debt-to-income ratio.
Definition and Goal
Debt-to-income ratios measure what percentage of your income is used to pay for debts. Lenders assume borrowers using a tall score ratio are far more likely to default on their obligations, and make use of the calculation to monitor borrowers.
The FHA utilizes two kinds of debt-to-income ratios: mortgage payment to income ratio–also known as front-end-to-income ratio–and overall fixed payment-to-income ratio. The mortgage payment income ratio measures the portion of your income you use to cover an FHA loan. The whole fixed payment-to-income ratio measures the portion of your income used to cover all your fixed monthly obligations, including car loans and credit cards.
The FHA is more flexible with debt-to-income ratio limits than many creditors. The most mortgage payment-to-income ratio is 29 percent, whereas the maximum overall adjusted payment-to-income ratio is 41 percent. If your score ratios transcend these limits, the FHA will not accept your loan.
Calculating your debt-to-income ratio is simple and straightforward. Insert your total mortgage payment (insurance, tax interest and main ), divide it by your gross monthly income and multiply by 100. For instance, if your mortgage payment is $500 and your monthly gross wage is $1,000, then your mortgage payment to income ratio is 50 percent (500/1,000*100). To figure your overall fixed payment-to-income ratio, then follow the same procedure. Add up your total mortgage payment and monthly fixed expenses (car loans, credit cards, insurance), split by your gross monthly income and multiply by 100. It is a good idea to figure out your eligibility criteria before you apply for an FHA loan, so it is possible to work on ways to lower your fixed expenses in case your current ratios are too large.
FHA debt-to-income ratios are a useful method to evaluate what loan payments you can afford. It is just as much a tool for borrowers as for creditors, because overstretching your finances could cause you to lose your home–or even worse, make you file bankruptcy. Don’t lie or provide misleading information as soon as your creditors request your income or adjusted expenditures. This is called land fraud and is, of course, prohibited. Regrettably for borrowers, lenders and the land market as a whole, this type of fraud is widespread. According to the FBI, land fraud accounts for 20 percent of mortgage fraud.