Too much debt to buy or refinance a home? Here’s your plan
When you apply for a mortgage, the lender will make sure you can afford it.
Doing so involves comparing your debts and your income — formally called your debt-to-income ratio, or DTI.
If your DTI is too high, you could have a hard time getting approved for a mortgage. However, there are ways to make the numbers work, even with a higher DTI.
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What is debt-to-income ratio (DTI)?
When applying for a mortgage loan, lenders want to know that home buyers aren’t taking on more debt than they can afford. Your debt-to-income ratio tells lenders how much money you spend relative to how much income you earn. This will help them determine how large a mortgage payment you can comfortably make.
DTI is expressed as a percentage that is determined by dividing your monthly minimum debt payments with your gross monthly income (pre-tax income).
For example, if you make $5,000 per month before taxes, and you owe $1,800 per month on student loans and minimum credit card payments, your DTI is 36% ($1,800 / $5,000 = 0.36).
Lenders look at two types of DTI when applying for a home loan.
Front-end DTI is limited to housing expenses and includes your potential monthly mortgage payment, homeowners insurance premiums, and property taxes.
Back-end DTI is more commonly used during a home loan application because it provides an overall view of your monthly financial wellbeing.
Back-end DTI looks at all of your recurring monthly minimum payments, including front-end DTI plus any monthly debt from credit cards, student loan payments, debt consolidation loans, auto loans and personal loans.
Your debt-to-income ratio typically doesn’t include basic household expenses or monthly bills for utilities, groceries, dining out, and entertainment. Instead the types of debt DTI focuses on is minimum monthly payments from lines of credit that are regular and recurring.
What’s the maximum DTI for a home loan?
Be mindful that each mortgage lender may have its own eligibility requirements and maximum DTI. Generally, though, a good debt-to-income ratio is around 36% or less and not higher than 43%.
Here are the common maximum DTI ratios for major loan programs:
- Conventional loans (backed by Fannie Mae and Freddie Mac): 45% to 50%
- FHA loans: 50%
- VA loans: No max DTI specified, but borrowers with higher DTI could be subject to additional scrutiny
- USDA loans: 41% to 46%
- Jumbo loans: 43%
How to get a loan with a high debt-to-income ratio
A high debt-to-income ratio can result in a turned-down mortgage application. Luckily, there are ways to get approved even with high debt levels.
1. Try a more forgiving program
Different programs come with varying DTI limits. For example, Fannie Mae sets its maximum DTI at 36 percent for those with smaller down payments and lower credit scores. Forty-five is often the limit for those with higher down payments or credit scores.
FHA loans, on the other hand, allow a DTI of up to 50 percent in some cases, and your credit does not have to be top-notch.
Likewise, USDA loans are designed to promote homeownership in rural areas — places where income might be lower than highly populated employment centers.
Perhaps the most lenient of all are VA loans, which is zero-down financing reserved for current and former military service members. DTI for these loans can be quite high, if justified by a high level of residual income. If you’re fortunate enough to be eligible, a VA loan is likely the best option for high-debt borrowers.
2. Restructure your debts
Sometimes, you can reduce your ratios by refinancing or restructuring debt.
Student loan repayment can often be extended over a longer term. You may be able to pay off credit cards with a personal loan at a lower interest rate and payment. Or, refinance your car loan to a longer term, lower rate or both.
Transferring your credit card balances to a new one with a zero percent introductory rate can lower your payment for up to 18 months. That helps you qualify for your mortgage and pay off your debts faster as well.
If you recently restructured a loan, keep all the paperwork handy. The new account may not show up on your credit report for thirty to sixty days. Your lender will need to see new loan terms to give you the benefit of lower payments.
3. Pay down (the right) accounts
If you can pay an installment loan down so that there are fewer than ten payments left, mortgage lenders usually drop that payment from your ratios.
Or you can reduce your credit card balances to lower your monthly minimum.
You want to get the biggest reduction for your buck, however. You can do this by taking every credit card balance and dividing it by its monthly payment, then paying off the ones with the highest payment-to-balance ratio.
Suppose you have $1,000 available to pay down the debts below:
The first account has a payment that’s nine percent of the balance — the highest of the four accounts — so that should be the first to go.
The first $500 eliminates a $45 payment from your ratios. You’d use the remaining $500 to pay down the fourth account balance to $2,500, dropping its payment by $25.
Total payment reduction is $70 per month, which in some cases could turn a loan denial into an approval.
4. Cash-out refinancing
If you’re trying to refinance, but your debts are too high, you might be able to eliminate them with a cash-out refinance.
The extra cash you take from the mortgage is earmarked to pay off debts, thereby reducing your DTI.
When you close on a debt consolidation refinance, checks are issued directly to your creditors. You may be required to close those accounts as well.
5. Get a lower mortgage rate
One way to reduce your ratios is to drop the payment on your new mortgage. You can do this by “buying down” the rate — paying points to get a lower interest rate and payment.
Shop carefully. Choose a loan with a lower start rate, for instance, a 5-year adjustable rate mortgage instead of a 30-year fixed loan.
Buyers should consider asking the seller to contribute toward closing costs. The seller can buy your rate down instead of reducing the home price if it gives you a lower payment.
If you can afford the mortgage you want, but the numbers aren’t working for you, there are options. An expert mortgage lender can help you sort out your debts, tell you how much lower they need to be and work out the details.
How to calculate debt-to-income ratio
Lenders value low DTI, not high income. Your DTI compares your total monthly debt payments to your before-tax income.
Calculating your DTI ratio is done by adding your monthly debt obligations together and then dividing that figure by your gross monthly income.
DTI does not include monthly bills for basic household expenses like utilities, health insurance premiums, food, or entertainment.
Instead, your DTI ratio includes the type of debt from lines of credit or housing expenses such as monthly mortgage payments, homeowners insurance premiums, HOA fees, car loans, personal loans, student loans, and credit card debt.
Total monthly debt includes housing-related expenses such as
- Proposed monthly mortgage payment
- Property taxes and homeowner’s insurance
- HOA dues, if any
The lender will also add minimum required payments toward other debt.
- Credit card debt
- Auto loans
- Student debt
- Debt consolidation loans
- Alimony and child support
When adding up debt, do not include the entire loan amount — just the monthly minimum payments.
Your monthly gross income is the total amount of pre-tax income you earn each month.
Formula for debt-to-income ratio
Divide your monthly payments by your gross monthly income, and then determine your DTI percentage by multiplying the resulting figure by 100.
- Monthly debt payments / monthly gross income = X * 100 = DTI ratio
For example, your income is $10,000 per month. Your mortgage, property taxes, and homeowners insurance is $2,000. Your car and credit card payments come to another $1,000. Your DTI is 30 percent.
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Lenders don’t favor applicants who make more money. Instead, they approve those with a reasonable ratio of monthly debt compared to their income.
In the above examples, the applicant who makes the least is the most qualified for a loan.
Getting a loan with high DTI ratio FAQ
According to the Consumer Finance Protection Bureau (CFPB), 43% is often the highest DTI a borrower can have and still get a qualified mortgage. However, depending on the loan program, borrowers can qualify for a mortgage loan with a DTI of up to 50% in some cases.
While lenders and loan programs all have their own DTI requirements; typically, a good DTI is 36% or lower.
Borrowers with a higher DTI will have difficulty getting approved for a home loan. Lenders want to know that you can afford your monthly mortgage payments, and having too much debt can be a sign that you might miss a payment or default on the loan. If you’re in this situation, try to pay down or restructure some of your bigger debts before applying for a home loan.
A commonsense approach can help reduce your DTI before beginning the home buying process. Increasing the monthly amount you pay toward existing debt, avoiding new debt, and using less of your available credit can all help lower DTI. Recalculating your DTI ratio each month will help you measure your progress and stay motivated.
Some home buyers may confuse debt-to-income ratio with credit utilization ratio, also known as debt-to-limit ratio and debt-to-credit ratio. Your credit utilization ratio shows how much of your available credit (credit limit) that you’re using. As an example, if you have a $100,000 credit limit across several credit cards and your current balance is $5,000, then your credit utilization ratio is 5%.
What are today’s rates?
Mortgage rates are low, and it’s an ideal time to get a rate quote. Low rates mean it’s easier to qualify, even with a high debt load.
Connect with a lender to learn whether you qualify for a mortgage at your current DTI, and what rate you might be eligible for.