Too much debt to buy or refinance a home? Here’s your plan

The Newsdesk
The Mortgage Reports contributor

In this article:

There are ways to get approved for a mortgage, even with a high debt-to-income ratio:

  1. Try a more forgiving program, such as an FHA, USDA, or VA loan.
  2. Restructure your debts to lower your interest rates and payments.
  3. If you can pay down any accounts so there are fewer than ten payments left, do so. Lenders usually drop that payment from your ratios at this point.
  4. Consider a cash-out refinance.
  5. Get a lower mortgage rate by paying points to get a lower interest rate and payment.

Tame your DTI, get approved

When you apply for a mortgage, the lender will make sure you can afford it.

Doing so involves evaluating the relationship between your debts and your income — formally called your debt-to-income ratio, or DTI.

If your DTI is too high, you could have a hard time getting approved for a mortgage. However, there are ways to make the numbers work.

First, you need to understand DTI.

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Lenders value low DTI, not high income

Your DTI is compares your total monthly debt payments to your before-tax income.

“Total monthly debt” includes housing-related items such as

  • Proposed mortgage payment
  • Property taxes and homeowner’s insurance
  • HOA dues, if any

The lender will also add minimum required payments toward other debt.

  • Credit cards
  • Auto loans
  • Student debt
  • Alimony and child support

For example, your income is $10,000 per month. Your mortgage, property taxes, and homeowners insurance is $2,000. Your car and credit card payments come to another $1,000. Your DTI is 30 percent.

 Housing Costs  Debt Payments  Income  DTI
 $2,000  $1,000  $10,000  30%
 $1,750  $800  $8,000  32%
 $1,500  $200  $6,000  28%

Lenders don’t favor applicants who make more money. Instead, they approve those with a reasonable ratio of monthly debt compared to their income.

In the above examples, the applicant who makes the least is the most qualified for a loan.

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Get approved with a high DTI

A high debt-to-income ratio can result in a turned-down mortgage application. Luckily, there are ways to get approved even with high debt levels.

1. Try a more forgiving program

Different programs come with varying DTI limits. For example, Fannie Mae sets its maximum DTI at 36 percent for those with smaller down payments and lower credit scores. Forty-five is the limit for those with higher down payments or credit scores.

FHA loans, on the other hand, allow a DTI of up to 50 percent in some cases, and your credit does not have to be top-notch.

Likewise, USDA loans are designed to promote homeownership in rural areas — places where income might be lower than highly populated employment centers.

Perhaps the most lenient of all are VA loans, which is zero-down financing reserved for current and former military service members. DTI for these loans can be quite high, if justified by a high level of residual income. If you’re fortunate enough to be eligible, a VA loan is likely the best option for high-debt borrowers.

2. Restructure your debts

Sometimes, you can reduce your ratios by refinancing or restructuring debt.

Student loan repayment can often be extended over a longer term. You may be able to pay off credit cards with a personal loan at a lower interest rate and payment. Or, refinance your car loan to a longer term, lower rate or both.

Transferring your credit card balances to a new one with a zero percent introductory rate can lower your payment for up to 18 months. That helps you qualify for your mortgage and pay off your debts faster as well.

If you recently restructured a loan, keep all the paperwork handy. The new account may not show up on your credit report for thirty to sixty days. Your lender will need to see new loan terms to give you the benefit of lower payments.

Verify your new rate (Sep 20th, 2021)

3. Pay down (the right) accounts

If you can pay an installment loan down so that there are fewer than ten payments left, mortgage lenders usually drop that payment from your ratios.

Or you can reduce your credit card balances to lower your monthly minimum.

You want to get the biggest reduction for your buck, however. You can do this by taking every credit card balance and dividing it by its monthly payment, then paying off the ones with the highest payment-to-balance ratio.

Suppose you have $1,000 available to pay down the debts below:

 Balance  Payment  Payment-to-balance ratio
 $500  $45  9.0%
 $1,500  $30  2.0%
 $2,000  $50  2.5%
 $3,000  $150  5.0%

The first account has a payment that’s nine percent of the balance — the highest of the four accounts — so that should be the first to go.

The first $500 eliminates a $45 payment from your ratios. You’d use the remaining $500 to pay down the fourth account balance to $2,500, dropping its payment by $25.

Total payment reduction is $70 per month, which in some cases could turn a loan denial into an approval.

Verify your new rate (Sep 20th, 2021)

4. Cash-out refinancing

If you’re trying to refinance, but your debts are too high, you might be able to eliminate them with a cash-out refinance.

The extra cash you take from the mortgage is earmarked to pay off debts, thereby reducing your DTI.

When you close your refinance mortgage, checks are issued directly to your creditors. You may be required to close those accounts as well.

5. Get a lower mortgage rate

One way to reduce your ratios is to drop the payment on your new mortgage. You can do this by “buying down” the rate — paying points to get a lower interest rate and payment.

Shop carefully. Choose a loan with a lower start rate, for instance, a 5-year adjustable rate mortgage instead of a 30-year fixed loan.

Buyers should consider asking the seller to contribute toward closing costs. The seller can buy your rate down instead of reducing the home price if it gives you a lower payment.

If you can afford the mortgage you want, but the numbers aren’t working for you, there are options. An expert mortgage lender can help you sort out your debts, tell you how much lower they need to be and work out the details.

What are today’s rates?

Mortgage rates are low, and it’s an ideal time to get a rate quote. Low rates mean it’s easier to qualify, even with a high debt load.

Check today’s rates. All quote requests can be started without a social security number, and there’s never any obligation to continue if you are not totally satisfied with your rate.

Verify your new rate (Sep 20th, 2021)