Most of us walk through our lives carrying debt. The average American today has more than 25k racked up in outstanding payments. It seems that having debt has become the norm, and it’s not a fun situation to live in. So, how can we combat this?
The good news is that debt is not a dead-end situation. An aspiring homeowner with a high debt-to-income ratio can still lower their ratio and get a loan.
What is debt-to-income ratio?
Debt-to-income ratio (DTI) is the amount of debt you have compared to your gross income, expressed as a percentage. It’s a key personal finance figure that indicates how much you owe and how much you bring in.
DTI can be split into two types of ratios: Front-end and back-end.
Front-end DTI
Your front-end DTI only includes your housing-related expenses. So, it’s the percentage of your monthly gross income that goes toward home expenses. These expenses include a mortgage payment, homeowners insurance, and property taxes.
Back-end DTI
Your back-end debt-to-income ratio includes your housing expenses plus all your other monthly debts. So, this percentage gives a better frame of reference for your spending habits. Thus, your back-end ratio is more important than your front-end ratio in the eyes of a lender.
Why it’s important
Your DTI is critical to your success in finding a mortgage loan. A high debt-to-income ratio can make it tough to reach your goals of homeownership. This is because your DTI is the percentage lenders look at when determining your qualification for a loan. Not only will it affect the terms of your loan, but it can also influence your interest rates and the amount of money you’re approved for.
So, now that you know the lower your DTI is, the better, how can you figure out what your ratio is?
How to calculate your debt to income ratio
It’s pretty simple to calculate your DTI percentage. Take the sum of your total monthly debts, and then divide that sum by your monthly household income. Then, multiply that number by 100 to see your percentage.
Your monthly debts include your monthly payments that are required, regular, and recurring. And your gross household income includes the pre-tax income you make each month.
To see this calculation written as an equation, we’ll call the sum of your total monthly debts ‘D’ and your total gross household income ‘I.’
(D / I) x 100
What’s the ideal debt-to-income ratio?
In most cases, a high debt-to-income ratio is anything over 50%. But, lenders typically prefer a DTI that’s below 36%. Anything below that is considered ideal as it shows you’ll have money left over to pay your mortgage after paying your existing bills every month.
How can I get a mortgage loan with a high debt-to-income ratio?
Although there will be more hoops to jump through with a higher DTI, there are ways you can still secure a loan.
Forgiving loans
Different loan programs will come with various limits for DTIs. Two popular types of home loans that accept high DTIs are FHA and VA loans.
FHA loans may take a DTI up to 50%. Also, you don’t need to have an excellent credit score to qualify for an FHA loan.
VA loans are recognized as the most lenient. You can have a pretty high DTI and still get mortgage approval as long as you have a high level of residual income. So, if you’re eligible for a VA loan, it’s a great route to take for a high-debt borrower.
Co-signer
Another way to get around a not-so-great debt-to-income ratio is to have another person sign on the loan. Your lender will calculate your DTI using both your and your co-signer’s incomes and debts. Thus, if you have a high debt-to-income ratio, a co-signer with a significantly lower DTI can boost your chances of securing a loan.
In addition to mortgage loans, a high DTI can also affect your chances of getting a personal loan or a car loan.
Personal loan
Securing a personal loan with a high debt-to-income ratio is pretty common. This is because personal loans are typically used for improving your financial situation. You can use a personal loan to pay unforeseen expenses or consolidate debt.
Car loan
You can get a car loan with a high debt-to-income ratio by extending the loan’s terms. This is the most popular way borrowers with high DTAs get approved for car loans.
How can I lower my DTI?
Having a high DTI can be overwhelming, but it’s not the end of the world. Here are a few strategies that can help bring your DTI down and get you closer to a mortgage loan approval.
Pay off your debts
Yes, this seems like a catch-22. The reason you have a high debt-to-income ratio is that you can’t pay off your debts in the first place. But, there are a few tips that can help victims of high DTIs eliminate debt.
Make a realistic plan and start by paying off your smallest outstanding debt in full.
Cut out or adjust other monthly payments that aren’t vital. These could include phone apps/games, gym memberships, and entertainment subscriptions.
Freeze your credit cards once you’re able to pay them off.
Reduce your spending
When your debt-to-income ratio is too high, you can lower it by simply cutting back on your monthly spending. Keep a journal of how much you spend on eating out, impulse shopping, and entertainment. Then, write down options for how you can reduce the frequency of those money-suckers.
Raise your income
You can combat a high debt-to-income ratio by increasing your total monthly income. Picking up more hours at work, adding a side hustle, or getting a promotion will all bring in more money. The more income you make, the lower your DTI ratio will be.
Cash-out refinance
If you have a high mortgage payment that’s contributing to your high DTI, you can opt for a cash-out refinance. A cash-out refinance with a high DTI will allow you to take a portion of your equity in cash. Then, you can use that money to pay off your outstanding debts, thus, lowering your DTI to a healthier percentage.
Debt consolidation loan
A debt consolidation loan enables you to put all or some of your current loans into one box. As a result, you’ll only have one loan payment to make each month. Plus, your new monthly payment may be less than the sum of what you were paying before.
If you have a high debt-to-income ratio, a debt consolidation loan can extend the time you have to pay off your debts. This way, you’ll be able to make smaller monthly payments.
Can I get a debt consolidation loan with a high DTI?
While it may be rare, some lenders give out debt consolidation loans to high DTI borrowers. If you do qualify, you might have to pay a high-interest rate, but a co-signer can help mitigate that risk.
At the end of the day, a high debt-to-income ratio isn’t permanent. It can be a pain to combat, but with the right amount of discipline, you can effectively lower your DTI.
Our mortgage experts will work with you to help lower your DTI while finding a mortgage you can afford.