How to improve your debt-to-income ratio and qualify for home financing

When you apply for a mortgage loan to purchase or refinance a home, the lender is going to look closely at several key digits. They’ll scrutinize your credit score, certainly. They’ll drill down into your salary and earnings, for sure. But they’ll also take a metrics magnifying glass to your debt numbers. Because the amount you owe others is an accurate reflection of your creditworthiness.

Indeed, one of the best ways for lenders to determine how good of a borrower candidate you are is to calculate your debtto-income (DTI) ratio, which equates to your monthly debt divided by your monthly income.

“It’s the percentage of your gross monthly income that goes toward mortgage or rent payments, credit card payments, auto loan payments, student loan debt and other debt obligations,” explains Marcos Sanchez, branch manager for Embrace Home Loans in Sandy Spring, Maryland.

Case in point: Say you have $4,000 in total monthly debt but earn $10,000 monthly in gross income. In this scenario, you divide the former by the latter and multiply by 100, which yields a DTI ratio of 40%.

Next to your credit score, your DTI ratio is likely the most important criteria evaluated by a mortgage lender, so it pays to have a preferable number here.

“Lenders pay close attention to DTI ratios because they are a good indicator of the consumer’s ability and willingness to make their mortgage payments on time. The lower your DTI ratio, the more confident the lender will be in you making your payments on time each month,” Sanchez adds.

By contrast, a high DTI “is a warning sign that the borrower might not be able to handle a new loan payment. Consequently, the lender may charge the borrower a higher interest rate to cover that risk,” notes Chris Panteli, a finance/investment expert and founder of LifeUpswing.com. “If your DTI is greater than 43%, your mortgage request may be denied entirely.”

The maximum DTI allowed will depend on the type of loan you are applying for.

“For conventional loans that will ultimately be bought by Freddie Mac or Fannie Mae, the highest DTI allowed is 45% in most cases,” Panteli says.

Experts say FHA home loans can go as high as 56% on the DTI ceiling, while VA loans frown upon ratios higher than 50% and USDA home loans prefer a DTI lower than 45%.

“You may be able to get a mortgage loan with a higher DTI ratio than these numbers, but you can likely expect the underwriting process to be more stringent,” Panteli cautions.

Consumer finance expert Andrea Woroch, based in Bakersfield (Kern County), notes that your income doesn’t necessarily have to be high to be considered for a mortgage loan, but that’s only if you have little to no debt.

“On the contrary, if you are carrying any loans for a car or school along with high credit card balances, a lender will need to see a solid income to compensate for those debts if you’re hoping to borrow a lot of money. It’s always a good idea to get a rough estimate of your DTI before you apply for a loan or meet with the lender so that you know where you stand and there are no surprises,” says Woroch, who recommends using one of the many free DTI calculators found online.

If you learn that your DTI score is undesirable, you can take steps to lower it.

“The first and easiest step is to lower your debts. The first debt you want to focus on is paying down high-interest credit card debt. I recommend transferring your credit card balance to a 0% balance transfer card; this way, all the money you put toward that card goes to the principal instead of interest fees,” Woroch recommends. “Secondly, think about which monthly expenses you can cut back on while boosting debt payments.

Look over subscriptions and memberships to see what you are using or can eliminate. Also, shop around for more affordable automobile and homeowner insurance quotes to see if you can save money.”

Next, investigate if you can refinance any of your current non-mortgage loans to capitalize on lower interest rates, which will lower your payments and improve your DTI.

Additionally, strive to earn more money.

“Are you up for a raise or promotion? Can you find a better-paying job? Can you use your free time to make some side income? This extra money can be reported as income and used to pay down debt faster, both of which will greatly improve your DTI,” she says.

In addition, pay your bills punctually, and aim to pay off your credit card balance in full every month.

“After making many of these suggested changes, your DTI should improve relatively quickly — even within a few short days,” says Glen Pizzolorusso, associate real estate broker with Compass in Fairfield County, Connecticut. “Be prepared for your mortgage lender to order a rapid update of your credit report and possibly require documentation to prove you’ve made the changes to your debt situation.”