In this article
- What is the DTI Ratio?
- Front-End DTI
- Back-End DTI
- What is the Maximum DTI for a Home Loan?
- Here are some common maximum DTI ratios for major loan programs:
- How to Get a Loan Even with a High DTI Ratio
- 1. Look for a More Forgiving Program
- 2. Debt Restructuring
- 3. Paying Down the Right Accounts
- 4. Cash-Out Refinance
- 5. Get a Lower Mortgage Rate
- How the DTI Ratio Is Calculated
- DTI Ratio Formula
- Getting a Loan with High DTI: Frequently Asked Questions
- What’s the Highest DTI Ratio to Qualify for a Mortgage?
- What’s a Good DTI Ratio?
- What Happens if My DTI Ratio is Too High?
- How Can You Lower Your DTI Ratio?
- DTI Vs. Credit Utilization
- What Are Today’s Rates?
If you are applying for a loan, the first thing the lender will do is ensure that you are actually able to afford it. Doing that involves comparing your debts and income, which is formally referred to as the debt-to-income ratio (DTI). If you have a DTI that’s too high, you may have a hard time being approved for a mortgage. Still, it is possible to make the numbers work, even if your DTI is higher.
What is the DTI Ratio?
When home buyers apply for a mortgage, lenders want to be sure that they don’t take on more debt than they are able to afford. The DTI tells lenders how much money you spend relative to the income you earn. It helps them determine how large a mortgage payment you are able to comfortably make. The DTI ratio is expressed as a percentage that’s calculated by dividing monthly minimum debt payments with the gross monthly income before taxes.
For instance, if you earn $10,000 per month (pre-tax) and you owe $2,000 per month on student loans and minimum credit card payments, then your DTI is 20% ($2,000 / $10,000 = 0.20).
Lenders look at 2 types of DTI when applying for a home loan.
It is limited to housing expenses and includes your potential monthly mortgage payments, property taxes, and homeowners’ insurance premiums.
It is more commonly used during a home loan application since it provides an overall view of your monthly financial wellbeing. The back-end DTI considers all recurring minimum monthly payments, which include front-end DTI along with any monthly debt from student loan payments, credit cards, personal loans, auto loans, and debt consolidation loans.
The DTI ratio usually does not include basic household expenses or even monthly bills for groceries, entertainment, dining out, and utilities. Instead, the types of debt that DTI focuses on is minimum monthly payments from regular and recurring lines of credit.
What is the Maximum DTI for a Home Loan?
Keep in mind that each mortgage lender may have its own maximum DTI and eligibility requirements. However, a good debt-to-income ratio is anywhere from 36 percent or lower and definitely not higher than 43 percent.
Here are some common maximum DTI ratios for major loan programs:
- Jumbo Loans: 43 percent
- USDA Loans: 41 to 46 percent
- FHA Loans: 50 percent
- Conventional Loans (backed by Fannie Mae and Freddie Mac): 45 to 50 percent
- VA Loans: No maximum DTI specified, but borrowers whose DTI is higher could be subject to extra scrutiny.
How to Get a Loan Even with a High DTI Ratio
A high DTI ratio may result in your mortgage applications getting declined. Fortunately, it is possible to get approved even with high debt levels. Here are some tips for doing just that:
1. Look for a More Forgiving Program
Different programs have different DTI ratio limits. For instance, Fannie Mae has its maximum DTI ratio set at 36% for applicants with lower credit scores and smaller down payments. 45% is usually the limit for those with higher credit scores or down payments.
FHA loans, on the other hand, allow a DTI of up to 50% in some instances, and you don’t need to have top-notch credit. Similarly, USDA loans are aimed at promoting homeownership in rural areas – places where income levels are likely to be lower than those of highly populated employment centers.
VA loans are perhaps the most lenient of all, which is zero-down financing reserved for both current and former military service members. DTI ratios for such loans are usually quite high, if justified by a high level of residual income. The VA loan is probably the best option for high-debt borrowers if you are lucky enough to be eligible.
2. Debt Restructuring
Refinancing or Restructuring Debt Can Sometimes Be a Great Way to Reduce Your DTI Ratio.
You can often extend student loan repayment over a longer term. You may be able to use a personal loan at a lower interest rate and payment to pay off your credit cards. Alternatively, you can refinance your auto loan to a longer term, a lower rate or both. You can lower your payment for up to 18 months if you transfer your credit card balances to a new one with a 0% introductory rate. This can help you qualify for your mortgage while paying off debts faster too.
Keep all the paperwork handy if you have restructured a loan recently. The new account might not appear on your credit report for 30 to 60 days. Your lender will have to see the new loan terms to give you the benefit of lower payments.
3. Paying Down the Right Accounts
If you are able to pay down an installment loan so that there are less than 10 payments remaining, mortgage lenders usually drop that payment from your ratios. Alternatively, you can reduce your credit card balances to lower the monthly minimum.
However, you want to enjoy the greatest reduction for your buck. Fortunately, it is possible to do this by taking each credit card balance, dividing it by its monthly payment, and then paying off the ones whose payment-to-balance ratio is the highest.
Suppose you have $1,000 available to pay down the following debts:
The first account has a payment that’s 9% of the balance, which is the highest of the 4 accounts, which means that it should be the first one to go.
The first $500 eliminates a payment of $45 from your ratios. You would use the remaining $500 to pay down the balance on the fourth account to $2,500, reducing its payment by $25. The total monthly payment reduction is $70, which is sometimes enough to turn your loan denial into an approval.
4. Cash-Out Refinance
If you would like to refinance but have very high debts, it might be possible to eliminate them using cash-out refinance. The extra cash you take from your mortgage is earmarked for paying off debts, thus reducing your DTI ratio.If you close on debt consolidation refinance, checks are issued to your creditors directly. You may have to close those accounts too.
5. Get a Lower Mortgage Rate
Dropping the payment on your new mortgage is one way to reduce your DTI ratios. You can do this by “buying down” the rate, which is essentially to pay points to get a lower rate of interest and payment.
Shop Carefully: Get a loan with a lower start rate, for example, a 5-year adjustable-rate mortgage as opposed to a 30-year fixed loan. Buyers need to consider asking the seller to contribute toward the closing costs. The seller can buy your rate down rather than reducing the price of the home if it gives you a lower payment,
If you are able to afford your desired mortgage, but the numbers are not necessarily working for you, options are available. Expert mortgage lenders can help you sort out your debts, tell you how much lower they should be and work out all the specifics.
How the DTI Ratio Is Calculated
Lenders value a low DTI and not high income. The DTI ratio compares the total monthly debt payments to your pre-tax income. To calculate the DTI, all you have to do is add all monthly debt obligations and divide the resulting figure by your gross monthly income.
The DTI ratio doesn’t include monthly bills for basic household expenses such as food, health insurance premiums, utilities, or entertainment. Instead, it includes the type of debt from lines of credit or housing expenses such as HOA fees, homeowners’ insurance premiums, monthly mortgage payments, credit card debt, student loans, personal loans, and car loans.
The total monthly debt includes housing-related expenses such as:
- Property taxes and homeowner’s insurance
- Proposed monthly mortgage payment
- HOA dues, if any
The lender will also add the minimum required payments toward other debts such as:
When adding up debt, don’t include the entire amount of the loan, just the minimum monthly payments. The monthly gross income is the total amount of income earned each month before taxes.
DTI Ratio Formula
Divide your monthly payments by the gross monthly income, and then calculate the DTI percentage by multiplying the resulting figure by 100.
Monthly Debt Payments / Monthly Gross income = x * 100 = DTI
For example, you have a monthly income of $10,000. Your property taxes, homeowner’s insurance, and mortgage all add up to $2,000 each month. Your credit car and car payments add up to another $1,000 per month. Your DTI is 30%.
|Housing Costs||Debt Payments||Income||DTI|
Lenders don’t particularly favor applicants that earn more money. Instead, they approve those with a reasonable ratio of monthly debt compared to their income. In the examples above, the applicant that earns the least is the most qualified for a loan.
Getting a Loan with High DTI: Frequently Asked Questions
What’s the Highest DTI Ratio to Qualify for a Mortgage?
The Consumer Finance Protection Bureau (CFPB) reports that 43 percent is usually the highest DTI that borrowers can have and still qualify for a mortgage. Depending on the loan program, however, borrowers can qualify for a mortgage loan with a DTI as high as 50 percent in some instances.
What’s a Good DTI Ratio?
Lenders and loan programs will all have their own specific DTI requirements, but a good DTI is typically 36 percent or lower.
What Happens if My DTI Ratio is Too High?
Borrowers with a higher DTI will usually have difficulty getting approved for a home loan. Lenders want to be sure that you are able to afford the monthly mortgage payments, and if you have too much debt could be an indication that you are more likely to either miss a payment or default on the loan. If you are in such a situation, try paying down or restructuring some of your bigger debts before you apply for a home loan.
How Can You Lower Your DTI Ratio?
A commonsense approach may help lower your DTI prior to the start of the home buying process. Avoiding new debt, increasing the monthly amount paid towards existing debt, and using less of your available credit are all effective ways to lower your DTI. Recalculating your DTI ratio every month will help you measure your progress and stay motivated.
DTI Vs. Credit Utilization
Home buyers sometimes may confuse the debt-to-income ratio with the credit utilization ratio, which is also referred to as debt-to-credit ratio and debt-to-limit ratio. The credit utilization ratio is used to show how much of the available credit limit is being used. For instance, if you have a credit limit of $100,000 across several credit cards and the current balance is $10,000, then your credit utilization ratio is 10%.
What Are Today’s Rates?
Mortgage rates are low and it is now the perfect time to get a rate quote. Low rates make it easier for you to qualify even if you have a high debt load. Connect with a lender today to find out whether you qualify for a mortgage at your current DTI and what rate you might be eligible for.