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To get a mortgage loan, your lender will check to ensure that you can afford it. A mortgage lender will look at your debt-to-income ratio to help make that determination. A high debt-to-income ratio can make it impossible to qualify for a mortgage.
But that doesn’t mean you don’t have options. We’ll cover how you can get a qualified mortgage even with a higher debt ratio.
What is debt to income ratio?
Your debt-to-income ratio (DTI) is how much money you spend relative to how much income you make. Mortgage lenders look at your DTI to help them determine if you are likely to afford your monthly loan payments. DTI tells mortgage lenders if you’re taking on more debt than you can afford.
DTI is expressed as a percentage by dividing your monthly minimum debt payments by your pre-tax (gross) monthly income.
Let’s say that you make $6,000 before taxes, for example. Between your auto loan, credit card minimum payments, and student loan debt, you owe $2200 a month. When you take 2,200 and divide it by 6,000, your DTI is 37%.
Front-end and back-end debt ratios are the two types of DTI that lenders look at.
Difference between front-end debt to income ratio and back-end debt to income ratio
The front-end debt ratio is also known as the mortgage-to-income ratio. It is a ratio that looks at the portion of a person’s income allocated toward mortgage payments.
This calculation is found by dividing the individual’s anticipated monthly loan payments by monthly gross income. The principal, interest, taxes, and mortgage insurance generally make up a mortgage payment.
It also considers other associated costs, such as the homeowners association (HOA) dues.
For example, let’s say that your anticipated mortgage expenses are $2600 ($2,400 for monthly loan payments and $200 for HOA costs). Your monthly income is $10,000. When you divide 2,600 by 10,000, you get a front-end ratio of 26%.
The back-end debt ratio considers your total monthly debt obligations, including your mortgage and other associated housing debt, relative to your gross income. Items that mortgage lenders typically include in your back-end ratio calculation include:
- Mortgage payments
- Real estate taxes
- Homeowners association dues (HOA)
- Homeowner’s insurance premiums
- Credit card payments
- Student loan payments
- Auto loan payments
- Personal loan payments
- Home equity loan payments
- Lines of credit payments
- Debt consolidation
- Child support
The back-end ratio gives mortgage lenders a better view of your overall monthly obligations. However, it still leaves plenty of monthly expenses out of the equation. The cost of gas, car insurance premiums, groceries, and utility bills are among the monthly charges the back-end ratio doesn’t consider.
Because the back-end ratio considers more than just your monthly housing expenses, lenders typically focus more on this income ratio to determine how much you can afford.
How to calculate your debt to income ratio
To determine your DTI, simply add up all your monthly debt payments. When calculating your back-end ratio, be sure to include your auto, student, personal, and other loans. Child support payments and alimony are also included.
Your rent, insurance, food, utilities, and other non-debt expenses should not be considered.
Now you can total your monthly before taxes. This includes your salary, dividends, and interest. Some lenders include alimony and child support payments.
The last step is to divide your total monthly debt payments by your total monthly income. By multiplying this result by 100 will get your DTI, expressed as a percentage.
What is a good and bad debt to income ratio?
The state of your financial health can be told by your debt-to-income ratio. So you’re probably wondering at this point what is considered a good or bad debt to income ratio.
The lower this ratio is, the better. A low debt ratio indicates that you don’t have too many debts to service relative to your cash flow.
Most traditional lenders look for borrowers that have a ratio of 36% or less. No more than 28% of that debt should go towards servicing the mortgage. 37% to 43% is often the upper limit of what many mortgage lenders will accept.
In certain cases, lenders like Fannie Mae may consider borrowers who have DTIs as high as 50%. These borrowers must meet other requirements, such as a specific credit score or cash reserve amount.
Here is a general guide you can use to understand your DTI ratio:
- Less than 36% – You likely have manageable debt relative to your income; Getting new lines of credit shouldn’t be a problem
- 36%-42% – Lenders become more concerned with your debt level at this point. It could make it harder to borrow money. Consider lowering your DTI by paying down your debt.
- 43% – 50% – This level of debt is difficult to pay off, and some creditors may decline applications for more credit. Consolidation plans are a good option if you have credit card debt that needs to be repaired. Student loan refinancing could help with student loan debt balances.
- Over 50% – Your borrowing options are limited, and your level of debt is difficult to manage. Debt relief options like bankruptcy are a possible consideration.
Can you get approved for a mortgage or other loan with a high debt to income ratio?
It’s possible to get approved for a mortgage or other loan if your DTI is greater than 36%. For example, you can likely find a mortgage lender if your DTI is around 43%. The tradeoff is that your interest rate will be most likely higher.
If you have other factors like a good credit score, some lenders may approve your application for these reasons.
43% to 50% is considered high risk so you’ll find fewer lenders willing to approve your applications. Most lenders won’t accept borrowers who have DTI above 50%. Some “bad credit” lenders will approve a loan. However, your interest rate will be considerably high. It’s often not worth taking out a loan in these cases.
What is the highest debt to income ratio to qualify for a mortgage loan?
Experts generally agree that anything above a 50% DTI is risky. Reducing your debt is the ideal scenario to not only improve your chances of getting approved for a mortgage loan, but for your finances.
The type of mortgage loan that you’re applying for will have different requirements when it comes to your DTI. Private lenders from financial institutions are typically not an option for high DTI borrowers.
How to get a loan with a high debt to income ratio
As discussed, the best-case scenario is to reduce your debt to improve your DTI. But in some cases, you might need to get approved for a mortgage loan sooner rather than later. Banks and credit unions will generally not approve borrowers with high DTI for one of their traditional mortgage loans. So your best bet is to look at government-backed loans.
Try government loans or a more forgiving loan program
The government backs several types of mortgage loans which help protect the financial institution if a borrower defaults. Basically, the government will pay off the remaining mortgage loan balance if a borrower is unable to repay it. There’s also other non-government loan programs that have more forgiving policies to consider.
The U.S. Federal Housing Administration backs FHA loans. The credit score requirements are more lenient than other types of mortgage loans. Your DTI can be as high as 57% in some cases.
The United States Department of Agriculture backs USDA loans. They can be used to buy and refinance homes located in eligible rural areas. Your DTI must be 41% or less to qualify.
The Department of Veterans Affairs backs VA loans. Borrowers must be eligible current and former members of the Armed Forces to qualify for these types of loans. The DTI requirement for VA loans can be as high as 60% in some cases.
DTI requirements aren’t set with conventional loans. You’ll generally need a DTI of less than 50% to qualify. However, in some situations, you could qualify for a conventional loan with a higher DTI.
Lower the amount you need from a loan
If you have a high DTI, consider lowering the amount you need to borrow. Lenders estimate your DTI using the amount you’re seeking to borrow from them. If you’re asking for less, you might get approved for a mortgage loan.
That means looking at less expensive homes for purchase. It could be a good way to still get into a new home now versus waiting until you pay down your debts.
Restructure your debts
If your existing debt is too high, restructuring it can save you money while improving your DTI. High-interest credit card ebts in particular are expensive. Look at credit repair companies and refinancing options that will combine your existing debt with lower interest and enable you to pay it off faster
Pay down accounts with the highest payment to balance ratio
Another option is to reduce the highest balances to lower your credit utilization. For example, let’s say you have a credit card with a credit limit of $10,000 with a $7,000 balance. The credit utilization ratio of that credit card is 70%
For the purposes of qualifying for a mortgage, you should pay down this balance as soon as possible to get your credit utilization under 30%.
Eliminate monthly payments by paying off accounts with lower amounts
Paying down a huge balance can take time. If you’re looking for something with more instant gratification to keep you motivated, pay off your accounts that have lower balances.
Consider debt consolidation programs
Debt consolidation is a good financial strategy for those with multiple debts. Debt consolidation will lower your interest rate and monthly payment amount to help improve your cash flow.
Will debt consolidation hurt your credit score
In the long run, debt consolidation should increase your credit score because it helps reduce your credit utilization (must also make on-time payments). In the short term, your credit score will drop because when you apply for debt consolidation, the lender will perform a hard inquiry on your credit, it’s considered a new credit account, and opening it will lower your average age of credit.
Get another job or increase your income
Not happy with your current job? Getting a higher-paying job can reduce your DTI so it might be the right time to consider a change. If that’s not an option, look for other ways to increase your monthly income. Side hustles and high-paying part-time jobs or weekend jobs are possible avenues to consider.
Get a co-signer or someone else on the loan with a better debt to income ratio
Do you have a family member or friend that has good credit and a low DTI that would cosign on your loan? A co-signer can help you get approved for a loan, often with a more reasonable interest rate and terms. Keep in mind that a possible downside is damaging the relationship with your co-signer if you don’t make the payments. Your co-signer will be on the hook for the loan.
Hopefully, this will help you figure out all of your options on how to get a loan with a high debt to income ratio. For obvious reasons, lowering your debt will be the best chance you have to get a better loan, but as you can see, there are still a lot of options for you to get the loan and life you’re looking for.