Today’s tough underwriting standards make the debt-to-income ratio a front runner in the decision to approve or deny your mortgage loan. In the past there was a bit of wiggle room when it came to slightly high DTIs, but today the rules are rather rigid. Any DTI over 43 percent is generally declined. This does not mean you are out of luck – there are simple ways to ensure that your ratio is low enough to get approved.
Know your Income
The first step is to understand your income. It is more complicated than simply stating the amount of money you make per year. For example, you may make a $50,000 salary at your job, but on your tax returns, you deduct $5,000 in non-reimbursed employee expenses as well as travel expenses. These numbers come directly off of your income. That $50,000 salary just became $45,000. This amounts to $416 less per month according to your potential lender. If your DTI was already close, you are likely over the 43% threshold now. This is why it pays to know your income. Do not just look at what your employment contract says you will be paid; take into consideration what your tax returns say, as this is the figure your mortgage lender will use. This will give you the best starting point when you are determining your debt-to-income ratio.
Determine your Bonuses or Commission
Before you overstate your income, you will need to annualize your bonus or commission income. If you receive any type of fluctuating income, it will be averaged over a period of 2 years. Chances are this means your figures will be much lower than you anticipated. Lenders do this in an attempt to make your income even throughout the year. If your bonus this year was $5,000, but last year it was only $2,500, the lender will use a 24 month average, using $312.50 as the addition to your monthly income, even though this year you technically made $416 extra per month. Knowing how to avoid overstating your income will allow you to stay within your means when looking for a new home or even when refinancing an existing mortgage.
Look at your Debts
Your debts play a large role in your debt-to-income ratio. In order to come up with an accurate number, your lender will use the minimum payment reported on the credit report. This may or may not differ from the minimum payment you are required to pay each month. It pays to pull your own credit report before applying for a mortgage to see if what each of your credit card companies or banks are reporting are accurate with your records. If there is a discrepancy you will have time to take it up with each creditor before applying for a mortgage. Keep in mind that whatever is reported on the credit report is what the mortgage lender is obliged to use when determining your outstanding debts.
Paying your Debts Down
If you find that your debt-to-income ratio is too high, you can pay your debts down before applying for a mortgage. This is one of the most effective ways in having a drastic impact on your ratios. If you have outstanding credit card debt, look for the card with the highest minimum payment and determine how it would affect your DTI if you paid it off. For example, if you have income of $50,000 reporting on your tax returns, a potential mortgage payment including taxes and insurance of $1,200 and other debts totaling $600 you will be right at the 43% threshold. If the borderline DTI bumps your interest rate up or makes it hard for you to get a loan at all, you can find a way to take off just $100 per month of your debt and your DTI will decrease to a little more than 40% – a much more comfortable ratio for lenders. This could mean paying off an entire credit card balance or lowering all of your balances so your minimum payments go down collectively.
Increase your Income to Lower your Debt-to-Income Ratio
It is likely easier said than done, but if you could find simple ways to increase your income, you could also lower your DTI. If you are married, consider using your spouse’s income to qualify for the loan. This is only feasible if your spouse does not have any other debts to bring to the table though. If he/she will also add several debts, the benefits of using the additional income may not matter. If this is not an option, you can wait until you get a raise, work some overtime or take on a second job. While increasing your income is usually the harder way to decrease a DTI, it is usually a successful way.
Making sure your debt-to-income ratio is well under the 43% benchmark most lenders have set is the best way to make your mortgage application look more attractive. Lenders are leery to lend to those who have a large DTI because borrowers that are stretched thin are much more likely to default on their loans. If you can use one of these simple ways to lower your expenses, you will have an easier time obtaining the mortgage you desire.Click to See the Latest Mortgage Rates»