Buying a home comes with many financial considerations, and one that often gets overlooked is the debt-to-income (DTI) ratio. This key percentage shows how much of your monthly income goes toward debt payments, helping lenders assess affordability.
In a nutshell
Neighbors Bank does not enforce a strict DTI ratio for USDA loans, but a high ratio can still lead to USDA loan denial. A high DTI implies that a substantial amount of your income goes to debt, which can make 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.
What is the maximum DTI for USDA loans?
USDA loans do not have an official debt-to-income limit. Like many other government-backed loans, the agency sets some loan qualifications while some are decided by the lender. In the case of USDA loans, many requirements are left to the lender, including DTI ratios and the minimum credit score needed to qualify.
Neighbors Bank does not have a maximum DTI limit, meaning we are willing to work with borrowers of all DTI ratios.
How DTI Works with a USDA Loan
There is a common misconception that 41% is the maximum DTI ratio accepted on a USDA loan. In reality, most lenders have flexible debt-to-income requirements, not only for USDA loans but other home loans as well. This misconception exists because of the USDA’s Automatic Underwriting System (GUS) requirement, which (among other things) requires a back-end DTI ratio of 41% for a borrower’s application to receive an automatic ‘refer.’ However, in this scenario, a borrower would also need a front-end ratio of 34%.
‘Refer’ means the loan would not get automatic approval and would need to be reviewed by a manual underwriter.
What is a USDA loan DTI ratio waiver?
If GUS provides a ‘refer’ result after reviewing a borrower’s file, lenders can approve a waiver to increase the max DTI from 34/41 to 34/44 if the borrower has strong compensating factors (like good credit or extra savings).
To figure out where your DTI ratio stands in the eyes of lenders, you need to understand the difference between the front and back-end debt-to-income ratios.
The Front-End Ratio (Housing Costs Ratio)
Also known as the PITI ratio, the front-end ratio tells lenders how much of your monthly gross (before-tax) income is dedicated to housing expenses.
PITI is a commonly used acronym for:
- 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
Your total PITI amount is found on your mortgage statement every month. Other potential components of your PITI might be HOA fees, condo charges, or special assessments.
A higher front-end DTI may indicate that a borrower is stretching their budget and could struggle with mortgage payments, but ultimately, what is regarded as acceptable is up to a lender.
The Back-End Ratio (Debt Ratio)
The back-end, or total debt ratio, represents how much of a borrower's gross monthly income goes toward total monthly debt payments. This includes:
- Housing expenses (mortgage principal, interest, property taxes, homeowners insurance, HOA dues)
- Payments for personal loans, credit cards, vehicles, and student loans
- Child or spousal support
- Payments towards collections or other judgments
- Other recurring debt obligations
Some monthly expenses, like phone bills or health insurance, aren't considered in this ratio.
Compensating Factors for a High DTI Ratio
If your DTI ratios exceed the standard 34/41 thresholds, compensating factors may justify loan approval despite some weaknesses in your financial profile. These can range from consistent employment history to significant savings.
How to Calculate Your DTI Ratio
To calculate your debt-to-income ratio, first calculate your monthly gross income. You can do this by checking your last month's pay stub or calculating your annual pre-tax earnings and dividing by 12. 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 monthly debt by your monthly gross income and multiplying by 100. Once you calculate both, the two DTI ratios are often written as "housing debt ratio/overall DTI" or "34/41."
Example Calculation
Let’s say a borrower has the following monthly debts:
- Gross Monthly Income: $5,000
- Mortgage Payment (incl. taxes & insurance): $1,800
- Car Loan: $600
- Student Loan: $500
- Credit Card Minimum Payment: $300
- Total Monthly Debt: $3,200
To calculate the Front-End DTI (Housing Ratio), you would take:
(1,800/5,000) x 100 = 36%
While the Back-End DTI (Total Debt Ratio) would be calculated as follows:
(3,200/5,000) x 100 = 64%
The example DTI ratio would be displayed as 34/64.
Still have questions?
A Neighbors Bank USDA loan expert can help answer any questions and clarify any queries or doubts. Reach out today!
Sources
https://www.rd.usda.gov/media/file/download/3555-1chapter11.pdf-3
With over 11 years in the mortgage industry, Matt Roy has spent the last 7 years as an underwriter. He’s passionate about understanding the “why” behind lending decisions and helping homebuyers succeed.
