by Christy Bieber | Feb. 5, 2021
You may still be able to borrow to buy a home.
When you're ready to buy a home, it can be really frustrating to find lenders don't want to give you a mortgage. Unfortunately, if you aren't a well-qualified borrower, that may be your fate.
Lenders consider many different factors when deciding whether to approve you for a mortgage loan. Your credit score is one of them, and your debt-to-income (DTI) ratio is another. Your DTI is your debt relative to your income, including your mortgage payment. If it exceeds a specific percentage (which can vary depending on the lender and loan you're trying to get approved for), you may not be able to get a mortgage to buy your home.
If that happens to you, you have four possible options.
You may notice one option is missing: Increasing your income. Unfortunately, this isn't necessarily the best approach to improving your DTI because lenders won't give you credit for wages you just started earning. You'd need to have earned the income for quite a while before lenders would count it.
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Since your debt is one of the two key factors in your debt-to-income ratio (along with income), reducing your debt balances can help you to get approved for a loan.
There's something to be aware of though -- lenders consider your monthly payments as well as your loan balances when determining your DTI. And paying down debt won't necessarily change those until the loan is paid off in full.
Let's say you pay a lump sum towards your loan principal or increase your monthly payment to pay it down faster. In many cases, your loan won't reamortize -- which means your lender won't recalculate the monthly payment according to your new balance. You'll end up paying off the loan sooner because you paid ahead of schedule, but that monthly payment will still impact your DTI until the debt is paid in full.
This doesn't always happen. With credit cards, for example, your minimum payment will go down as your balance does. But depending on the kind of debt you have, you should know that paying more towards it won't necessarily improve your DTI unless you can retire the debt entirely. And that can take a long time.
Reducing your monthly payments can help improve your DTI, and refinancing may be one way you can do that. For example, you might be able to substantially lower your required monthly payments if you refinance a bunch of high-interest debt into a low-interest personal loan. In this case, while your total debt balance won't change, your new monthly payment will be lower.
Some mortgage lenders may still disqualify you based on your total loan balance, or based on the fact you recently applied for new credit, so ask your lender how they'd view this action.
Of course, you may decide it makes sense to do it anyway, even if it doesn't immediately enable you to get a mortgage loan. After all, who doesn't want to lower their monthly payments? Just be sure you don't lengthen your repayment timeline so much that you also raise your total interest costs.
In some cases, it's easier to qualify for government-backed loans, even if you have a higher DTI. For example, you may be able to get approved for an FHA loan with a debt-to-income ratio as high as 50%.
There are a number of options to look into, including FHA, USDA, and VA loans. Sometimes, there are extra costs to pay up front with these loans compared with a conventional mortgage. But they're still worth considering if you can't get a traditional home loan.
Finally, if you reduce the amount you want to borrow on your home loan, you'll also lower your monthly debt obligations. This could bring your DTI below the permissible level and allow you to get approved. You could do this by either buying a less expensive home or making a larger down payment so you don't have to borrow as much.
You should also rate shop carefully among mortgage lenders. If you can find a lender with a lower interest rate, you'd also lower your monthly payment and potentially bring your DTI to an allowable level.
The right option will depend on your timeline for achieving your homeownership goals, the amount of available spare cash, and your potential lender's willingness to work with you. Your homeownership dream doesn't necessarily have to come to an end if a lender says you have too much debt to get approved for a loan. The important thing is to explore all the possible solutions.
Chances are, interest rates won't stay put at multi-decade lows for much longer. That's why taking action today is crucial, whether you're wanting to refinance and cut your mortgage payment or you're ready to pull the trigger on a new home purchase.
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