How High Can Your Debt-to-Income Ratio Be for a USDA Loan?

You probably already know that your credit score and income can impact your chances of being approved for a USDA loan, but are you aware that your existing debts can also play a major role?

All mortgage companies – USDA lenders included – set a maximum debt-to-income (DTI) ratio that borrowers must meet to qualify for a loan. We'll explain DTI and how it works, USDA debt-to-income ratio requirements, and what you can do if your numbers exceed program limits.

Key Takeaways

• USDA lenders use your debt-to-income ratio as one way to judge your creditworthiness.

• Your front-end DTI, which covers mortgage payments, property taxes, homeowner's insurance, and other housing-related costs, can be as high as 34% of your gross monthly income for a USDA loan.

• Your back-end DTI includes all debt obligations, with the USDA setting a maximum limit of 41%.

• You may qualify for a debt ratio waiver if your application has positive compensating factors.

What Is DTI and How Does It Affect My USDA Loan?

Your debt-to-income ratio is a vital factor lenders use to gauge your creditworthiness. Simply put, it measures how much of your monthly income is allocated to your prospective mortgage and other debt obligations.

Borrowers with a high debt-to-income ratio have less leeway in their budgets and may be more likely to default on their payments. Conversely, borrowers with a low DTI may be seen as less risky and get quoted more favorable interest rates.

Lenders consider two different debt-to-income ratios: front-end DTI and back-end DTI. While 28% and 36% ratios are considered ideal targets, respectively, USDA guidelines allow for a maximum front-end DTI of 34% and a back-end ratio of 41%.

Front-End DTI

Also referred to as the housing DTI, PITI ratio, or top ratio, your front-end DTI is the percentage of your monthly income your proposed housing expenses would take up. Items included in this calculation are:

• Your principal and interest payments

• USDA annual fee (0.35%)

• Property taxes

• Homeowners insurance

• Applicable association dues

USDA lenders have historically sought a front-end DTI of 29% or lower. However, the USDA recently enhanced its guidelines to allow borrowers to have a front-end ratio of up to 34%. This change comes as rising housing prices make it more challenging for buyers to meet old DTI standards.

Back-End DTI

Also called the total DTI and bottom ratio, the back-end DTI ratio for USDA loans assesses your cumulative current debts, including the mortgage you're applying for. Some of the payments included in your back-end DTI are:

• Your monthly housing expense

• Automotive loans

• Personal loans

• Credit card/line of credit minimums

• Court-ordered debts, such as alimony or child support

• Tax repayment plans

• Wage garnishments

• Student loans (loans not currently requiring repayment are assessed at 0.5% of the outstanding balance)

• Co-signed debts (unless another party to the debt has made on-time payments for at least the past 12 months)

USDA lenders have a maximum back-end DTI limit of 41%, although some compensating factors, covered later, may allow you to exceed that figure.

How Does USDA DTI Compare to Other Loan Types?

The USDA has the most lenient front-end DTI requirements, apart from the VA, which has no set limit. However, the USDA’s maximum backend DTI with exceptions is on the lower end:

Calculating Your USDA Loan Debt-to-Income Ratio

Calculating your USDA loan debt-to-income ratio is simple if you know your gross monthly income and current debts and if you have a good idea of your new home’s housing expenses.

Here’s an example scenario with two buyers, David and Shannon, and how their debt obligations translate into a USDA DTI ratio:

David and Shannon want to use a USDA loan to purchase a three-bedroom, two-bathroom home on four acres in a USDA-eligible area. The purchase price is $225,000.

David earns a monthly income of $5,000, and Shannon works part-time, grossing $3,000 a month.

Calculating Housing DTI

The monthly principal and interest payment on their 30-year, 6% mortgage would be $1,349. Assuming property taxes are 1% of the home's value and a homeowners insurance premium of $200 per month, housing expenses (including the 0.35% USDA annual fee) would total $1,802.

Dividing the housing expenses by their total qualifying income ($1,802 / $8,000) equals a front-end DTI of under 23%, well below the maximum USDA housing ratio of 34%.

Calculating Total DTI

In addition to the home they want to purchase, David and Shannon have several other debts. David has a $450 monthly truck payment, while Shannon's car runs $300. The couple has joint credit card debt with a minimum monthly payment of $250, and Shannon has a student loan payment of $150 due each month.

Combined with their $1,802 housing expense, this totals $2,952 in monthly debt obligations. Dividing this figure by their combined income ($2,952 / $8,000) gives a total USDA debt-to-income ratio of 37%, which is under the 41% program limit.

Based on their 23% and 37% debt-to-income ratios, David and Shannon are eligible for a USDA-backed mortgage.

Ways to Improve Your DTI

Maybe your debt level is too high to qualify for a mortgage, or perhaps you just want to reduce your DTI to benefit from lower interest rates. Regardless of your motivation for doing so, here are a few ways you can lower your debt-to-income ratio for USDA loans.

Pay Off Debts Where Possible

Paying off your existing debts does more than help you qualify for a USDA mortgage – it's also a vital step in improving your overall financial health. While it likely isn't possible to pay down every account, paying off high-rate and smaller balances can help reduce your debt-to-income ratio.

Reduce Installment Debts to Ten or Fewer Payments

Your lender might not count installment debts with ten or fewer remaining payments so long as the monthly amount doesn't constitute more than 5% of your monthly income. For example, if your qualifying income is $8,000, monthly debts of up to $400 with ten or fewer payments could be omitted.

While some loan programs forbid the practice, the USDA allows you to pay down outstanding accounts to meet the ten-month requirement.

Consolidate Remaining Debts

If you have a considerable amount of debt remaining – particularly debts with high interest rates – consolidation may help reduce your total DTI. For example, a borrower with a monthly income of $5,000 who consolidates $1,500 of monthly payments down to $950 would see an 11% debt-to-income ratio reduction.

Add a Co-Borrower or Co-Signer

Adding a co-borrower or co-signer can allow you to use their income to offset your high DTI ratio. Keep in mind, however, that any debt obligations that the new party has would also be calculated in the debt-to-income ratio.

USDA Compensating Factors and Debt Ratio Waivers

When an applicant has at least one compensating factor, the USDA gives lenders the ability to grant a debt ratio waiver and allow a maximum total debt-to-income ratio of 44% instead of the standard 41%.

The list of acceptable USDA compensating factors that qualify for a waiver includes:

• Post-closing cash reserves equal to at least three months of your PITI housing expenses

• Applicants – excluding self-employed applicants – with continuous employment with their current primary employer for a minimum of two years or with two years of continuous social security or retirement benefits

• The proposed front-end DTI not exceeding your current housing costs by the lesser of 5% or $100

• Buying an energy-efficient home according to current International Energy Conservation Code (IECC) standards

Keep in mind, however, that qualifying for a debt ratio waiver through compensating factors requires that all borrowers have a credit score of at least 680.

Don’t Forget About Other USDA Requirements

Your debt-to-income ratio is an integral part of qualifying for a mortgage. Still, it is just one of the many USDA requirements. Even with an ultra-low DTI, you will only be eligible for an agency-guaranteed mortgage if you meet the other USDA guidelines.

• The home must be located in a USDA-designated eligible rural or suburban area.

• Credit score requirements vary by lender, but many look for a score of at least 640. However, it is possible to find lenders accepting scores well below 600.

• You cannot earn more than 115% of the median household income for your area.

• The home you’re purchasing must be a single-family residence, although non-income-producing ADUs may be allowed.

• The home must be used as your primary residence.

• The property cannot be income-generating, such as a working ranch or farm. You may also not earn income from leasing land or other aspects of the site.

• You'll need cash on hand to cover closing costs, which often run from 3% to 5% of your loan amount. The 1% upfront guarantee fee is eligible to be wrapped into your mortgage. You could be able to include some or all of your closing costs if the property appraises for more than your contracted price. You may also qualify for down payment assistance to help with the burden.

The Bottom Line

A USDA loan can be a powerful tool for purchasing a home with zero money down, but you need to meet USDA DTI requirements to qualify. In most cases, this is a maximum front-end (housing) DTI of 34% and a back-end (total) DTI of 41%. However, the latter can go as high as 44% with acceptable compensating factors.

For an individualized picture of your USDA debt-to-income ratio and any other loan options, check out today's current rates and apply with a reputable and experienced USDA lender.