Updated July 23rd, 2019
Carrying too much debt is one of the main roadblocks for many home buyers who apply for a mortgage. One thing lenders look at when determining whether they think you can pay back a mortgage is your debt-to-income ratio. If you’re worried that your debt-to-income ratio may be too high to qualify for a mortgage, you may have some options you weren’t aware of.
If you want to buy a house and are wondering the best way to get approved for a mortgage, use the services of an expert full-service buyer’s agent experienced in their local market. Good buyer’s agents have built relationships with lenders in their local area and can guide you in preparing for the application process to give you the best chance at getting approved for a mortgage. Find a top agent in your neighborhood to get started.
What is debt-to-income ratio?
Your debt-to-income ratio is the sum of all of your monthly debt payments divided by your gross monthly income. For example, if you bring in $5,000 per month gross income (before taxes, insurance, or any other deductions) and you have credit card payments, car loans, or personal loan payments that total $2,500 each month, you’d divide $2,500 by $5,000 and get .5 or 50%. Your debt to income ratio, in this case, would be 50%. Note that expenses such as groceries, utilities, and gas rarelyrarely factor into your debt-to-income ratio, so you’ll want to leave those out when making your calculations.
What is an acceptable debt-to-income ratio?
The general rule for a “Qualified Mortgage” is to have a debt-to-income ratio of 43%. A “Qualified Mortgage” is a term created by the Consumer Financial Protection Bureau to designate lenders who have followed the ability-to-pay rule, which means they have certain consumer protections in place to make sure they don’t lend to consumers who do not have the financial ability to handle the loan. Some lenders may even use a 36% debt-to-income ratio limit as a cut -off.
How does debt-to-income ratio affect my ability to buy a home?
When you need a mortgage to buy a home, your debt-to-income ratio directly affects what type of mortgage product you may qualify for. If you have a low debt-to-income ratio, it represents to the lender your ability to handle the burden of a monthly mortgage payment.
When you have a high debt-to-income ratio, a lender may not think you can handle the addition of a mortgage payment. If you cannot get approved for a loan to buy a home because your debt-to-income ratio is too high, then you must work on lowering your debt-to-income ratio.
What is the highest debt-to-income ratio to qualify for a mortgage?
According to the Ability-to-Repay rule or the “Qualified Mortgage Rule” created by the Consumer Financial Protection Bureau to protect consumers following the 2008 mortgage crisis, the highest debt-to-income ratio to qualify for a mortgage should be 43%.
However, some lenders will accept a higher-debt-to-income ratio because of an exemption in the rule if the lender can prove by other means that the consumer would be able to make payments on the mortgage. The highest debt-to-income ratio quoted by lenders who will consider high debt-to-income ratios is currently 50%.
Where can you get a loan if you have a high debt-to-income ratio?
Different lenders offer different debt-to-income ratio limits, but consumers with high debt-to-income ratios have to prove their ability to pay by other means. For example, while Fannie Mae and Freddie Mac recently raised its debt-to-income ratio from 45% to 50%, borrowers must also have at least 12 month’s worth of cash reserves and the loan must be less than or equal to 80% of the property value.
If you don’t qualify for Fannie Mae or Freddie Mac, you might qualify for an FHA loan. For an FHA loan with a debt-to-income ratio of over 43% the lender is required to provide proof of why they believe the consumer has the ability to pay a monthly mortgage over the life of the loan.
VA loans have a general limit of 41% but if you can prove you have additional residual income, you may qualify for a VA loan with a debt-to-income ratio higher than 41%. VA residual income requirements vary depending on where you live and the size of your household.
What is the maximum allowable debt-to-income ratio for an FHA loan?
FHA uses two different debt-to-income ratios. The “front-end” ratio looks at housing-related debts such as a monthly mortgage payment and property taxes. The “back end” ratio involves all of your debts including the mortgage but also credit cards, car loans, personal loans, etc.
According to official FHA guidelines, debt-to-income ratios limits are 31% on the front end, and 43% on the back end. But the FHA can make exceptions if your back-end ratio is as high as 50%, if you can qualify in other ways such as having cash reserves or some other income. It’s on a case-by-case basis.
How can you decrease your debt-to-income ratio?
Mathematically speaking, you can decrease your debt-to-income ratio by decreasing your debt, restructuring your debt to lower your monthly payments, or increasing your gross monthly income. If you cannot increase your income, here are some options you can try to decrease your debt-to-income ratio.
Pay off the loans you have
If you can, try to double or triple up on your loan payments to get rid of them faster. If you have credit card balances, the more you pay off, the lower your balance will be. The lower your balance on your credit cards, the lower your monthly payments will be which will directly affect your debt-to-income ratio.
Restructure your debt
Remember that your debt-to-income ratio is not based upon the amount of debt you have, but the amount of your monthly payments you make towards your debt. There are ways to restructure your debt that can lower your monthly payments. If you have credit card payments and personal loans, look into consolidating unsecured debts with a personal loan. By extending the life of the loan, you can lower your monthly payments thereby lowering your debt-to-income ratio.
Consider cash-out refinancing
Cash-out refinancing allows you to replace your current mortgage with a new mortgage that has better terms. It might decrease the amount of your monthly payments, offer a lower interest rate, change the number of years of the loan or allow you to cash out the equity in your home that has built up. If you lower the monthly payments using a cash-out refinance, it will lower your debt-to-income ratio.
Pay points for a lower interest rate
Mortgage points allow you to pay fees directly to the lender — called “points” — during closing when you’re buying a house for a lower interest rate. If you have a lower interest rate, you’ll have lower monthly payments and a lower debt-to-income ratio.
Each point costs 1% of your mortgage. For example, if your mortgage is $300,000, it would cost you $3,000 to lower your interest rate a certain amount. How much your interest rate is lowered with each purchased point depends upon the lender. A good local buyer’s agent can guide you toward lenders who offer pay points for locking in a lower interest rate and lower your debt-to-income ratio.
Top FAQs for High Debt-to-Income Ratio Buyers
If you’re trying to qualify for a mortgage with a high debt-to-income ratio, it’s in your best interest to be honest with yourself about whether it’s a good idea to add more debt to your budget. Sometimes just because you can qualify for a mortgage, it doesn’t mean it’s a good idea. If you’re certain you can handle a mortgage payment with a high-debt-to-income ratio, these FAQs may help you further.
How much debt can I have and still get a mortgage?
Lenders measure your debt levels in relation to your gross income. To figure your debt-to-income ratio, they add all of your recurring debts including your housing costs, credit cards, car payments, and any personal loans. The upper limits of the debt-to-income ratio to qualify for a mortgage is between 43%-50% depending on the lender and your financial portfolio.
While 43% may be acceptable for a mortgage lender, keep in mind that lenders use the gross income figure of your salary to determine your debt-to-income ratio. As you may know, gross income does not pay the bills. This is why you need to make up your own mind about whether you can have a high debt-to-income ratio and still handle a mortgage without struggling to make ends meet.
Can you get a loan with a high debt-to-income ratio?
You can get a loan with a high debt-to-income ratio from some lenders if you meet other qualifications set by those lenders. Other qualifications could be a high credit score along with proof that you have cash reserves or other forms of residual income that were not calculated in your debt-to-income ratio. Your ability to get a loan with a high-debt-to-income lender depends upon your individual financial portfolio and that lender’s requirements.
Does debt-to-income ratio affect credit score?
Debt-to-income ratio levels do not affect your credit score directly. They are a mathematical tool used by lenders to determine your ability to pay back the loan. However, if you have a high debt-to-income ratio, chances are you may have a high credit utilization ratio which affects your credit score.
A credit utilization ratio is the amount of debt you carry overall compared to the amount of credit available to you. For example, if you had several credit cards with total credit limits of $10,000, and you were carrying balances that added up to $5,000, this would give you a credit utilization score of 50% which would affect your overall credit score. A good credit utilization score is 30% or less. Your credit utilization ratio makes up 30% of your credit score.
What is counted in debt-to-income ratio?
To get an overall picture of your ability to pay back a mortgage, lenders generally look at your “back-end” debt to income ratio. The debts counted in your back-end debt-to-income ratio can include any recurring payments such as car payments, student loan payments, credit card payments, personal loan payments, child support payments, alimony payments, mortgage payments, property taxes, mortgage and homeowners insurance.
The sum of these payments is then divided by your gross (before taxes or deductions) monthly income. Sources of income that are counted in your debt-to-income ratio can include wages, salaries, tips, bonuses, pension, social security payments, child support, alimony, and any other additional monthly income.