Buyers who have a large amount of debt certainly understand how overwhelming it can be to pay off their loans. Every month, they see money go toward loans that could have been saved or spent on something more productive.
But there is good news for people in debt. The first set of good news is that you’re not alone. The second set of good news is that even with a high amount of debt, you can still take on a mortgage and purchase your dream home.
How? The secret is finding a high debt to income (DTI) mortgage lender. Buyers with a 50% debt to income ratio can still afford a home.
What is debt-to-income ratio?
How does a lender know whether they will be giving a loan to someone with high debt? They don’t look at the dollar amount of debt – they look at the debt to income ratio.
The debt to income ratio compares just that: the amount of debt someone owes each month to their monthly income. If you make $10,000 a month, but $5,000 of that income is going toward paying off debt, you have a 50% debt to income ratio.
Why does the debt-to-income ratio affect my ability to buy a home?
Debt is hard to pay off as it is. When you take out a mortgage loan, you will have to make monthly payments for up to 15 or 30 years to pay off the cost of the mortgage. If you are already spending 50% of your monthly income on student loans or credit card balances, there will be little wiggle room left to pay off your mortgage. The higher your DTI ratio, the riskier you become for defaulting on your loan.
Loan Terms For Buyers With a High DTI Ratio
Lenders want to make sure they get their money back (with interest.) In order to decrease the risk of defaults, they offer conditions on loans. The loan terms may include higher interest rates or private mortgage insurance. Lenders may offer private mortgage insurance (PMI) that guarantees that the loan will be paid back in case of a default. Loans with PMI often come with higher monthly payments. Loans are more likely to have PMI and higher interest rates if the buyer has a high DTI ratio.
If you’re hesitant to believe that a lender would want to give a loan with someone who has a high DTI ratio, you’re not alone. But lenders understand how easy it can be to fall into debt. Students come out of college these days carrying five or six digits in debt, but they still have the means to budget and become first-time home buyers.
Where to Look For Loans if You Have a High DTI
Taking out a loan with a high DTI ratio just became easier. Fannie Mae recently raised the debt to income ratio limit on their loans. Buyers with DTI ratios as high as 50% can get loans backed by Fannie Mae. (Fannie Mae isn’t a lender; it buys and assumes the risk of mortgage loans and then sells them to lenders.)
In the past, conforming loans were not the best option for home buyers with a high DTI ratio. Now that Fannie Mae has increased the accepted DTI ratio, buyers can look at more conforming loan options than before.
If your DTI is high, start your search with more forgiving conventional loan programs with the federal government. FHA loans, USDA loans, and VA loans will give you the best chance of getting a mortgage approval.
How to Know Your Lender Isn’t Taking Advantage of You
This information can be a lot to digest for first-time home buyers. The “safety nets” of mortgage insurance and interest rates aren’t always reassuring, either. No one wants a lender to take advantage of them, especially when they accrued their debt at school.
If you are worried about your loan terms, be sure to consult a handful of professionals that can help you prepare a budget and compare loan terms. Not all loans are created equal; do your research before you start your mortgage application.
How to Decrease DTI Ratio and Increase Loan Opportunities
If you have some time, you don’t have to apply for the first loan that will accept your current DTI ratio. There are ways to decrease your DTI ratio and get affordable home loans.
(Clever tip: Remember, DTI ratio isn’t the only factor that mortgage banks use to determine loan terms. Credit scores and down payments may also affect your qualifications.)
Pay off the loans you have.
If you want to take the simplest route toward a debt-free life, pay off your current debt. The more money you put toward your current loans, the sooner you can eliminate monthly payments and claim to be debt-free. Without this debt, you can apply for even more loan programs with lower interest rates and more affordable loan terms.
Restructure your debt.
Buyers who want to pay off debts may want to look into debt restructuring. This process may include taking out an additional loan to pay off current debts or asking lenders to discharge or forgive certain debts. Talk to a financial advisor about debt restructuring before you take out additional loans.
Consider cash-out refinancing.
Buyers can restructure their debt with a cash-out refinance. This process increases the overall amount of your current mortgage in exchange for cash. Cash can be used to pay off other debts or put a higher down payment on th property.
Pay points for a lower interest rate.
You don’t have to succumb to high interest rates. Talk to lenders about paying points on your mortgage. “Paying points” are fees that can reduce your interest rates. The lender determines the price of these fees based on the amount of money you owe and your current interest rate.