One way that lenders determine how much money you can borrow is with a debt-to-income (or DTI) ratio. Your DTI ratio shows what percentage of your paycheck is going to pay your debts every month.
A higher DTI ratio means more of your monthly pay is going toward obligations like your housing payment, student loans, car payment and other expenses. Lenders want to make sure it’s comfortable for borrowers to pay back the amount they’re borrowing—you still need to buy groceries, after all—and a DTI ratio is a good way for them to quantify that.
Let’s take a look USDA loan requirements and guidelines for DTI ratio.
Calculating Your DTI Ratio for a USDA Loan
To calculate your debt-to-income ratio for the purpose of USDA loans, you first need to figure out how much you and any co-borrower make in a month.
Take the annual pre-tax amount and divide by 12, or just check your pay stubs for the last month. Be sure to use the amount you’re paid before any tax withholding, healthcare costs, or retirement savings are taken out, not the amount that you actually take home every month.
The USDA considers two ratios, which are often written like this: 29/41. The first number is the ratio of your monthly housing debt to your gross monthly income, and the second is your overall debt-to-income ratio.
PITI and the Front-End Ratio (29%)
The top DTI number, sometimes called the “top ratio,” “front-end ratio,” or “PITI ratio,” represents your total monthly housing debt obligation as a percentage of your gross monthly income.
PITI stands for principal, interest, taxes, and insurance, and is the number that will show up on your mortgage statement every month - or what you see when using our USDA loan calculator. The principal is the amount of loan you’re paying back, interest is the interest on that loan, taxes are your real estate taxes, and homeowners insurance is required.
PITI also includes any additional insurance payments, like flood insurance, and any HOA dues, condo fees, or special assessments.
Optimally, your proposed PITI won’t be more than 29 percent of your gross monthly (i.e. pre-tax) income, but it’s possible to have a higher front-end DTI ratio and get USDA loan approval.
The Back-End Ratio (41%)
The second number, called the “bottom ratio,” “back-end ratio,” or “total debt (TD) ratio” is the relationship between your major monthly debts and your gross monthly income.
Here are some examples of debts that would be included in your total debt ratio:
- PITI (or total housing payment)
- Student loan payment
- Personal loan payment
- Credit card payment
- Car payment
- Child or spousal support payment
- Collections payments or other judgments
- Co-signed loans, unless you have 12 months of proof you are not paying the loan
Some bills that you pay every month aren’t included in your total debt ratio. They include:
- Phone bills
- Childcare expenses
- Voluntary retirement savings contributions
- Health insurance premiums
Lenders will calculate your back-end DTI ratio by looking at all of your major monthly expenses, including your new projected housing payment. The USDA guideline is 41 percent, although it’s possible to exceed that and still obtain a USDA-backed loan.
We’ll explain that shortly, but first let’s look at an example.
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Example DTI Ratio Scenario with a USDA Loan
Let’s look at an example. If your annual gross household income is $60,000, then your gross monthly income is $5,000.
In this example, let’s say you’re buying a $150,000 home with a 30-year loan at a fixed 4.5 percent interest. Your monthly principal and interest payment would be $767.70.
We’ll add estimated monthly amounts for property taxes and homeowners insurance, along with the monthly charge for USDA’s mortgage insurance premium. The total monthly housing payment for this example loan comes out to about $1,025 per month.
That’s just 20.5% of your gross monthly income of $5,000, so your front-end DTI ratio would be below that 29 percent guideline.
To continue with this example, we’ll say that you have a $300 a month car payment and owe $400 a month in student loans. That puts your total major monthly debts at about $1,725 leaving you with a back-end DTI ratio around 34 percent.
So, in this case, our example homebuyer is well within the USDA’s DTI ratio guidelines. But what happens if your ratios are higher than what the USDA typically wants to see?
The good news is it’s still possible to obtain a USDA-backed loan even if your DTI ratios exceed these basic benchmarks.
Debt Ratio Waivers & Compensating Factors
Borrowers who have strong compensating factors may be able to get a USDA loan despite having higher DTI ratios. Compensating factors are basically positive attributes that help convince underwriters you have the willingness and ability to repay a mortgage loan.
Compensating factors can include things like solid cash reserves, a strong job history and more. Borrowers with sufficient compensating factors may be eligible for a debt ratio waiver, which allows lenders to make loans to borrowers with front- and back-end ratios above 29 percent and 41 percent, respectively.
Talk with a USDA loan specialist if you have questions about DTI ratio and what might be possible.
Income Limits for USDA Loans
DTI isn’t the only way your income factors into whether or not you qualify for a USDA loan.
The USDA and lenders look at repayment income for the purposes of making sure borrowers can handle their new monthly mortgage payment. But they also consider your household income in relation to where you’re buying.
USDA loans are designed to help low-to-middle-income workers buy property in rural and suburban areas. So there’s actually a limit to how much your household can make to be eligible for a USDA loan.
Generally, you can’t exceed 115 percent of the median income for your area. The USDA and lenders consider income only from borrowers and co-borrowers when evaluating debt ratios and whether you can afford a mortgage. But they’ll look at the entire household income (except for certain qualified deductions) when evaluating whether you fall under the qualifying income guidelines for your area.
The bottom line is there isn’t just one income consideration for USDA loans. But there’s a lot of flexibility when it comes to DTI ratio and being eligible for these $0 down loans.
A USDA loan specialist can help you evaluate your specific debt and income situation.