DTI ratio Archives - Stated-Income

Is there anything more nerve-wracking than filling out a mortgage application? As you answer the in-depth questions, you wonder if you are saying the wrong thing. Can one little factor really leave you with a turned down application? In some cases, it can, but there are some flexibilities involved. For instance, the DTI is a key factor in your mortgage application. However, it is not a black or white type decision. Many other considerations are at play. We discuss them below.

What is the DTI?

DTI stands for debt ratio. It is the amount of outstanding debt you have compared to your monthly income. The good news is lenders consider your gross monthly income or income before taxes. The other good news? They don’t count things like electrical bills, gas bills, or your costly cell phone bill. They only count bills reporting on your credit report. Car payments, mortgages, and credit cards are the most commonly included payments. Student loans and personal loans count too, though.

Lenders figure out your debt ratio by totaling up your monthly payments. This includes minimum credit card payments, plus the full amount of any other loan payment. They then divide the total liabilities by the gross monthly income. This is the debt ratio. But, there are two debt ratios.

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The Two Types of Debt Ratios

Lenders look at two debt ratios: front and back-end.

The front-end ratio is the total mortgage payment compared to your gross monthly income. Your total mortgage payment equals your principal, interest, real estate taxes, homeowner’s insurance, and mortgage insurance (if applicable). This total divided by your gross monthly income equals your front-end ratio. Just how high that ratio can go depends on the loan program and lender. In general, you should see maximums as follows:

Conventional loans – 28%
FHA loans 31%
USDA loans 29%

The back-end ratio is your total monthly payments. This includes the debts we discussed above plus your mortgage payment. Again, different programs and lenders have different thresholds, but you should see the following:

Conventional loans – 36%
FHA loans – 43%
USDA loans – 41%
VA loans – 41%

The VA loans are the exception to the rule in most cases. Rather than focusing on debt ratios, they focus on your monthly disposable income. This is the money left over after you pay your bills each month. They require a minimum amount of disposable income for different areas of the country as well as different family sizes. They credit their low default ratio to the attention they pay to disposable income.

Why the DTI Matters

It is a direct relationship – the more debt you have, the harder it is to make your payments on time. Put yourself in a lender’s shoes. If someone came to you with a debt ratio of 43%, would you want to give them new money? They already have their hands pretty full with the debts they have. How do you know that they will be able to keep up with their mortgage payments? Sure, in the beginning it might be okay, but after a few months or a year, will they still be able to do the same thing? What about the next 30 years? That is a long time to take a risk on such a large investment.

You Can Lower your Debt Ratio

The good news is if you have a high debt ratio, you are not out of luck. With a little patience and hard work, you can get the DTI down. How you do it depends on your situation. If you have extra money each month that you throw into savings, use it to start paying down your debts. Figure out which debt will have the largest impact on your DTI and hit that one first. If you have multiple credit cards, you may want to pay those down or off to get your minimum payments lower. It may not even take that much. Only you know how much debt you have out there.

If you cannot pay your debt down or off, consider consolidating it into one loan. This way you only pay one interest charge. This could lower your debt ratio enough to get you qualified for a loan. If you cannot qualify for a consolidating loan or you don’t want another loan, other options include:

Get a second job and use the money to pay down debt
Pay as much as you can each month whenever you have extra money
Use windfalls such as tax returns or bonuses to pay your debt off

These are just a few suggestions to help you get your debt ratio down. There is no right or wrong way to make this happen. You must do what works for your situation, but keep in mind there are many other factors at play here. We talk about them below.

There are Many Other Factors

Your DTI is not the only deciding factor regarding your loan application. There are a few other factors including:

Credit scores – The higher the better, obviously. Each loan program has its own requirements as does each lender.
Stability of your employment/income – The more stable your employment and income, the better off your chances of approval. If you change jobs often or you have constantly decreasing income over the years, you pose a higher risk than someone with stable income/employment.
Assets – Not every loan program requires assets, but if you have them, they can give you an advantage. Lenders look at assets as reserves, or money you can use to pay your mortgage if your income stopped. This is a very positive aspect of any loan application.

The bottom line is you have to pay close attention to your debt ratio. But, you also have to monitor the other aspects of your loan application. The lender looks at everything like puzzle pieces. They work hard to put it all together so they can see your risk level. Sometimes one bad factor does not preclude you from approval, but you won’t’ know unless you apply.

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The concept of adding a co-borrower is a common practice in the mortgage industry. It’s a practical move to share the costs of holding a mortgage or help you qualify for a bigger loan that you might not be approved on your own. In the initial or later stages of mortgaging, you can put in another name as a borrower to your loan.

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During the Application

When you ask a spouse, a friend or a family member to sign up on a mortgage with you, you are basically “pooling” all your income, assets and credit history together.

With the ability to repay rule in place, lenders are required to do a capacity check requiring traditional or alternative documentation as in the case of stated income loans. In the course of this verification, they might find that your monthly debts relative to your monthly income, as measured by the DTI ratio, is too high. If your co-borrower has a steady income (and that he/she has a lower debt-to-income ratio), it will help you qualify.

Similarly, you and your co-borrower could add your assets such as cash deposits, stocks and bonds to qualify for a loan with a bigger amount perhaps. Lenders check assets to see if these could support your closing costs, fees, and mortgage payments. There is also a reserve requirement that depends on the type of property you are buying.

To be clear, a co-borrower with a stellar credit will help you qualify and possibly get a lower rate only if you have a fairly good credit record yourself. Lenders will consider the lower of the two credit scores and if your score falls further behind, it won’t help in your application.

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During a Refinance

You can refinance to add a co-borrower to the loan. Just like when applying for a new mortgage, you and your co-borrower go through the verification process anew, income, assets and liabilities and credit history be under review.

Adding a co-borrower to an existing mortgage through a refinance is different from adding him/her to the title deed of your house. Except when he/she is related to you by blood or a spouse, a mortgage co-borrower does not have a security interest in the property although he/she has to pay back the loan with you.

Without a Refinance

You can skip refinancing and add a co-borrower to the mortgage but only to a certain extent. For instance, you add someone to the mortgage to put into writing his/her promise to pay some or all of your mortgage debt.

If your purpose is to add a child, spouse or parent, you are better off adding them to the mortgage deed, as mentioned above. They can be co-owners but not co-borrowers so they won’t have to be held equally responsible for repaying the loan.

Otherwise, you still need to refinance so you can add a co-borrower on top of getting a low rate, taking cash out of your home, shorten or extend your loan term, etc.

Be sure to ask your lender about the implications of getting a co-borrower and the options to remove him/her should there be a falling out as in the case of divorce.

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Why the DTI is Key for a Mortgage Approval