When you apply for a mortgage, your lender will look at a variety of factors, including your debt-to-income ratio. If it’s too high, chances are you won’t get the loan. Each loan program has requirements regarding the DTI.
So does a high DTI mean you can’t secure a loan? Keep reading to learn how you can work around it.
A Closer Look at the DTI
First, you should have a solid understanding of how lenders look at the debt-to-income ratio. In basic terms, it’s a comparison of your gross monthly income to your monthly debts. The lender will break your debts into two categories, though.
- Housing debts – Principal, interest, taxes, and insurance
- Other debts – Credit card debt, auto loans, student loans, child support, etc.
The lender will not include the cost of daily living, such as utilities or the cost of food.
The lender will take your debts and figure out your front-end and back-end ratio. The front-end is the housing ratio and the back-end is the total debt ratio or the comparison of all monthly debts to your gross monthly income.
Conventional loans require debt ratios of 28/36 and FHA loans require DTIs of 31/43, as a couple of examples.
So what happens if you exceed those ratios? Keep reading to see what happens next.
Look Outside of the Conforming Loans
Conforming loans have the strictest requirements. As we stated above, they want a 28/36 debt ratio. They can be slightly forgiving in this area if you have other compensating factors. Usually, a higher down payment helps to offset the 28/36 requirement. The more money you put down on the home, the more invested you are in the home. This gives the lender reassurance that you’ll do what you can to make your payments on time.
If you don’t have the higher down payment and you have the high DTI, your best bet is to look to other more forgiving programs, such as government-backed programs.
Government-Backed Programs are a Good Option
You have several government-backed programs to choose from when looking at loans. The most common is the FHA loan. You only need a 3.5% down payment, a 580 credit score, and you are allowed a 31% front-end ratio and 43% back-end ratio. These requirements are fairly flexible, but lenders are okay with it because the FHA guarantees the loans.
In other words, the FHA promises the lender that they will pay them back a portion of the funds they lose if you default on the loan. This makes it easier for lenders to lend you the money knowing that they won’t walk away empty-handed.
You may also choose from a couple of other government-backed loans, but they are restricted to certain borrowers:
- VA loans – If you are a veteran of the military, you may qualify for this flexible financing option. You won’t need to put any money down and only need a 620 credit score. The VA allows a debt ratio up to 43% in most cases, but they may allow a slightly higher ratio with the right compensating factors.
- USDA loans – If you make less than 115% of the average income for your area, you may qualify for a USDA loan. But, you have to buy a home in a rural area. According to the USDA, this means outside of the city limits. It could be right outside those limits and qualify though. The USDA allows debt ratios as high as 29/41.
Subprime loans also provide you with a viable option when you have a high DTI. These loans are held by the lender, so they can make up their own rules. They don’t sell the loans to investors, which means they can make their own requirements, including allowing a high DTI.
Subprime loans are not always a bad thing. They can be great loans that allow borrowers that would otherwise not get approved, get the loan they need. They are often known as portfolio loans too – they are just loans that are outside of the scope of the standard Qualified Mortgages.
Changing Your High DTI
If you still can’t get qualified with one of the above programs, you may have to look at your debts and figure out a way to change your high DTI. Below are a few of the most common options:
- Pay your credit cards down – If you have several credit cards, try paying the balances down to lower your minimum monthly payment. You can choose which card(s) you want to pay to lower your DTI the most. Of course, it’s best if you pay the cards off altogether, but if that’s not possible, lowering the balances should lower your monthly required payment.
- Transfer your credit card balances – If you can secure a 0% balance transfer credit card, consider transferring your credit card balances over to lower your minimum monthly payment.
- Pay your installment loans down – Many lenders don’t include any installment payments in the DTI if you have less than 10 payments left. Try paying your installment loans down enough to get to this point and it won’t be included in your DTI.
- Borrow less – If your high DTI is preventing you from getting a loan, try a lower loan amount. This may require you to change your plans regarding the price of a home or require you to put more down on the home, but it may help you get approved. Just make sure it’s a decision you can live with and manage.
- Consolidate your debts – If you are refinancing your home, you may include the debts that make your DTI too high in a cash-out refinance. This way you eliminate the debts and lower your DTI at the same time.
You have several mortgage options if you have a high DTI. Don’t give up hope. Instead, shop around and figure out which options are available to you. If you can’t find a viable loan program, you may want to work on your debts to help lower your DTI.