Your debt-to-income ratio (DTI) is the total of all of your monthly payments divided by your monthly income. DTI is expressed as a percentage for underwriting purposes. When an underwriter calculates DTI as part of your pre-qualification or application package, he or she will include the proposed mortgage payment, any car payments or other installment debts, minimum credit card or other revolving payments, and proposed utilities, taxes and insurance. Alimony, child support, and other court-related payments are also included in the DTI calculation.
A smaller DTI increases the likelihood that you will be approved for a loan. Most lenders prefer a DTI of 40% or lower and may even offer better loan terms to a borrower with an exceptionally low DTI. Is the DTI preventing you from getting pre-approved or from getting the loan terms you want? Here are a few ways to lower your DTI quickly:
Pay Off a Debt
The most straightforward way to reduce DTI is to reduce the numerator (i.e. your monthly payments). Consider paying off a debt or paying down a credit card to reduce the required minimum payment. However, run through the scenarios you’re considering with your L.O. first. Loan qualification standards usually allow for a range of DTI at each threshold, so make sure it’s worth parting with your cash before you do. Plus, you will need to retain a reasonable level of cash reserves to show creditworthiness.
If you do choose to pay off or pay down debt, keep a paper trail. It will take up to 30 days for your credit report to reflect the change and you may want to close on your new home before then. Also, some underwriters will want to call the creditor to verify verbally that the debt has been resolved.
A smaller DTI increases the likelihood that you will be approved for a loan.
Add a Co-Borrower
Adding a co-borrower to your loan application will probably increase the denominator of your DTI (assuming the new borrower’s monthly income is greater than his or her monthly debt payments).
Increase Your Down Payment
A larger down payment will lower the monthly principal and interest payment on your mortgage, thereby lowering the DTI that your underwriter will assume for qualification purposes. Plus, an increase in down payment shows your lender that you are willing to take on a larger stake in the collateral (the house) and may result in better loan terms overall. As with debt payoff, run this scenario by your L.O. before you commit to a larger buy-in.
Shop For Smaller Houses
Less square footage means lower utilities, taxes, and insurance.
A Word of Caution
DTI is an important part of the loan qualification package. Your lender will check and re-check this number before closing. Do not open new debt after you have been pre-approved and do not run up the debt on your credit cards during the time you’re shopping for a home. The underwriter will see the new debt before final approval and the resulting increase in DTI could jeopardize your approval.
DTI is just one piece of the loan application package. For a more detailed analysis of your purchasing power, contact the loan team at Ruoff.