For many home purchasers, qualifying for a mortgage is not only a tough challenge but also one that ends unhappily: They get rejected.
The reasons for the turndowns typically involve multiple factors: below-par credit scores, inadequate documented income, little or no savings.
But a new survey by credit-score giant FICO offers a peek inside the heads of credit-risk managers at financial institutions. Researchers asked a representative sample of them what single factor makes them most hesitant to fund a loan request — in other words, what’s most likely to prompt them to say no.
Tops on the list? Surprise, it’s not your credit scores. And it’s not how much you’ve got for a down payment or what you have in the bank. It’s your DTI — your debt-to-income ratio. Nearly 60 percent of risk managers in the FICO study rated excessive DTIs as their No. 1 concern factor; that’s five times the percentage who picked the next biggest turnoff.
Yet many new buyers have only a rough idea in advance of an application — even for a preapproval letter — about their own DTIs, how lenders view them and what sort of limits they’re likely to encounter.
Debt-to-income ratios for home loans are the most direct indication about whether you are going to be able to afford to repay the money you want to borrow.
Debt ratios for home loans have two components: The first measures your gross income from all sources before taxes against your proposed monthly housing expenses including the principal, interest, taxes and insurance that you’d be paying if the lender granted the mortgage.
As a general target, lenders like to see your housing expense ratio no higher than 28 percent of gross monthly income, though there is flexibility to go higher if other elements of your application are strong. In May, according to mortgage software and research firm Ellie Mae, the average borrower who obtained home-purchase money through investors Freddie Mac and Fannie Mae had a housing expense ratio of 22 percent. Federal Housing Administration-approved borrowers had average housing expense ratios of 28 percent.
The second DTI component, called the back-end ratio, measures your income against all your recurring monthly debts. These include housing expenses, credit cards, student loans, personal loan payments and others. Under federal “qualified mortgage” standards that took effect in January, your back-end-ratio maximum generally is 43 percent, though again there is wiggle room case by case.
Most lenders making loans eligible for sale to Fannie or Freddie prefer not to see you anywhere close to 43 percent. In May, according to Ellie Mae, the average approved home-purchase applicant had a back-end ratio of 34 percent. Even at FHA, which tends to be more lenient on credit matters than Fannie or Freddie, the average back-end ratio for buyers was 41 percent. The average for denied applications was 47 percent.
A good place to learn more about DTIs and to compute your own is Fannie Mae’s “Know Your Options” site, www.knowyouroptions.com, which includes calculators and other helpful tools.
The new FICO survey found that the second-leading cause of concern for loan officers is “multiple recent [credit] applications.” Lenders take them as signals that you are seeking to add on even more debt, which could affect your ability to repay the mortgage money you’re seeking.
In third place as an instant turnoff: credit scores. Most lenders want to see FICO scores well above 700 — Fannie and Freddie averages were in the 755 range in May; FHA-approved scores averaged 684.
Bottom line: If you want to be successful in your mortgage application, be aware of these key turnoff points and take steps to avoid the tripwires. Most important: Wait until your DTI ratios tell you that you can afford the house you want and that lenders won’t reject you out of hand.
Ken Harney’s e-mail address is firstname.lastname@example.org.