Curve

Qualifying for a mortgage can be hard with high DTI. A new rule in 2020 could change that

Peter Miller
The Mortgage Reports contributor

Ditching DTI could make mortgage borrowing a lot easier

Meeting the standard debt-to-income ratio, or “DTI,” is a challenge for many mortgage borrowers.

One of the most common reasons lenders deny loan applications is because a borrower’s monthly payments are too high compared to their income.

Now there’s a serious effort to ditch the DTI requirement altogether. Without it, a lot more borrowers could qualify for financing.

But if the reform doesn’t go through, there’s a chance DTI requirements could become a lot stricter by 2021.

If you planned to buy in the next few years, you might think about applying sooner rather than later.

Verify your new mortgage rate. Start here (Oct 18th, 2019)

Mortgage debt-to-income ratios explained

Lenders consider many factors when looking at a mortgage application.

One of the most important things they look for is the debt-to-income ratio, or “DTI.”

DTI compares a borrower’s gross monthly income (meaning the money they take home before taxes) to their recurring monthly debts (things like credit card, auto loan, and student loan payments). For mortgage purposes, income can also include nontaxable payments for things such as alimony or child support.

Take one example of how DTI is calculated for a mortgage loan:

  • Gross monthly income: $8,000
  • Recurring monthly bills: $2,000
  • Monthly housing costs: $2,000
  • DTI ratio: $2,000 + $2,000 / $8,000 = 50%

For mortgage purposes, this borrower has a DTI ratio of 50%.

Current DTI rules allow this applicant to qualify for a mortgage — even though the standard limit is 43%. This accommodation is called the “GSE patch”.

But without the “patch,” this applicant would not qualify. So the question most future home buyers and refinancing homeowners are asking is, “Should I get a mortgage soon before I don’t qualify anymore?”

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DTI rules today

Different loan programs actually have different DTI requirements for borrowers to qualify for a mortgage.

  • Conventional loans (backed by Fannie Mae/Freddie Mac) traditionally require 43%
  • FHA and USDA loans traditionally require 43%
  • VA loans traditionally require 41%

It’s important to note that these “traditional” requirements are not set in stone. With adjustments and exceptions, it’s entirely common for various programs to allow much higher DTIs.

In fact, despite the 43% limit on conventional mortgages, lenders very often take on customers with higher DTI ratios.

This exception, which applies to conventional loans backed by Freddie Mac and Fannie Mae, is known as the “GSE Patch” — and it has a huge impact.

The “GSE Patch,” which lowers DTI requirements for conventional loans, has helped more than 3.3 million homeowners get mortgages over the past five years.

According to the Urban Institute, is has allowed an additional 3.3 million borrowers to obtain mortgages during the past five years.

These people may not have qualified for a mortgage at all if the 43% rule was strictly enforced.

However, the GSE patch is set to end in January 2021.

How DTI rules could change for better or worse

If the GSE patch ends, and no other rule replaces it, Fannie Mae and Freddie Mac would become unable to buy loans with a DTI greater than 43%.

This could put millions of future homeowners in jeopardy, considering that the GSE patch has helped so many home buyers qualify for mortgages in recent years.

The GSE patch also allows private lenders to be more competitive with government loan programs. If it ends, that could mean fewer options and price competition for consumers.

So, what’s the “for better” scenario?

One option would be to extend the GSE patch and let conventional loans keep bending the rules. Many see this as a patchwork solution to a larger problem.

The better solution, according to a coalition of major lenders and regulators, would be to do away with DTI requirements in mortgage lending altogether.

The Urban Institute points to three arguments in favor of eliminating the DTI rule:

  1. DTI ratios are often measured incorrectly, which means some homeowners aren’t getting a fair shake
  2. High-DTI mortgages aren’t always riskier; they can be offset with better credit, big down payments, or alternate forms of income and assets not included in DTI totals
  3. FICO scores (credit scores) and loan-to-value (LTV) ratios are often better predictors of a borrowers ability to pay than DTI is

If DTI requirements go away, it could make mortgages much more accessible. Buyers with a DTI over 43% would have access not only to government loans — like FHA, USDA, and VA — but to privately-backed loans as well.

When it comes to mortgages, the more lender options you have, the better. The ability to compare rates and closing costs and choose the most competitive lender can help buyers save thousands on their mortgages.

If the GSE patch ends in January 2021, and DTI rules haven’t otherwise changed, home buying options could become a lot more restrictive

Thinking about buying or refinancing? Here’s what the DTI change means for you

If you have a high DTI ratio — whether because you have large debts, lower income, or live in an expensive metro area — you have a few options in light of the proposed DTI change.

First, you could apply now, and take advantage of the already-favorable DTI rules set by the GSE patch.

You could also keep an eye on Washington and wait for new legislation to pass, eliminating the DTI rule altogether. This might open up your borrowing options and make mortgage costs more competitive.

If you’re in the early stages of house hunting and didn’t plan to buy for a couple of years, you could wait until 2021. But this route runs the risk that you won’t qualify for a mortgage if you have a DTI over 43% and need a Fannie Mae or Freddie Mac loan.

Remember: None of this applies if you’re in the market and eligible for an FHA, VA, or USDA loan. These government-backed loan types will not be affected by DTI rule changes.

Your next move

If you go the “play it safe” route — applying for a mortgage sooner rather than later just in case DTI rules change for the worse — there’s one big benefit.

Mortgage rates are currently at historic lows and predicted to stay that way for the near future.

Applying now could help buyers with high DTI not only qualify but also snag a great mortgage rate that will help them save over the life of their loan.

Check rates from major lenders today. Start here (Oct 18th, 2019)