How to Lower Debt to Income (DTI)

Ratio for Mortgage

When you apply for a mortgage, your lender will examine your overall financial health. They will obtain a credit report, ask for proof of income, and calculate your debt-to-income (DTI) ratio. Qualifying for a mortgage loan requires a healthy DTI ratio. To increase your chances of getting approved for a loan, follow these practical tips to lower your debt-to-income (DTI) ratio and improve your financial health. Learn about what debt-to-income ratio is, how to calculate it, and effective strategies to reduce it.

What Is Debt-to-Income Ratio?

Your debt-to-income ratio is the amount of monthly recurring debt payments compared to your gross monthly income. For instance, let’s say that your gross monthly income is $5,000. You have a total of $2,000 of recurring debt obligations, which include a car loan, rent, and a credit card balance. To calculate your DTI ratio, you can divide your minimum payment and debts ($2,000) by your gross monthly income ($5,000). In this scenario, the result would be 0.40, or 40%. Generally speaking, you want your DTI to be 50% or less because this provides enough financial leeway to cover other expenses.

Not all of your monthly expenses are used to calculate DTI. When assessing your debt-to-income ratio, lenders will only examine certain bills and obligations. These include rent or mortgage payments, car loans, student loans, credit card debts, or other monthly debt payments. They also include recurring obligations like child support and alimony. Your DTI does not include miscellaneous expenses like utility bills, home repairs, groceries, daycare, commuting expenses, health care/insurance, or car insurance. 

DTI can be divided into two subtypes: front-end and back-end debt-to-income ratio.

Understanding Front-End and Back-End DTI

1. Front-End Debt-to-Income Ratio (Housing Expenses):

Front-end DTI is the ratio between your gross income and your current or projected housing expenses. This figure will include your base mortgage payment, property taxes, mortgage insurance, homeowners’ insurance, and homeowners’ association dues when applicable. When evaluating your creditworthiness, lenders will assess your total DTI and your front-end DTI. Generally, lenders want your front-end DTI to be under 35%. However, some loan programs and lenders have slightly different thresholds.

2. Back-End Debt-to-Income Ratio (Debts):

Back-end DTI is generally larger than front-end DTI and represents the total recurring debts that you owe compared to your gross monthly income. The back-end DTI includes the front-end expenses (mortgage payment, property taxes, mortgage insurance, homeowners’ insurance, and homeowners’ association dues) and the recurring obligations we spoke of previously (car loans, student loans, credit card debt, child support, and alimony). Breaking down DTI into front-end and back-end can help you better understand which financial obligations are making the biggest impact on your creditworthiness.

Practical Tips and Tricks to Lower Your Debt-to-Income Ratio

If you’ll be applying for a mortgage soon and want to know how to lower debt-to-income ratio, remember these tips and tricks:

1. Pay Down Debt

Paying down debt is the most straightforward way to reduce your DTI. The fewer debts you owe, the lower your debt-to-income ratio will be. Suppose that you have a car loan with a monthly payment of $500. You can begin paying an extra $250 toward the principal each month to pay off the vehicle sooner. This extra cash will reduce your overall debt faster and save you money in interest. However, your DTI will not drop until your car loan is paid in full. DTI does not take into account the total amount of debt you owe; instead, it analyzes your monthly expenses in relation to your gross monthly income.

2. Consolidate Debt

Debt consolidation is the process of combining multiple monthly bills into a single payment. You can consolidate debt by obtaining a personal loan and using those funds to pay off multiple loan payments, such as smaller loans and credit cards. The monthly payment of your debt consolidation loan will be lower than the cumulative amount of all of your old payments. Therefore, it will drop your DTI.

3. Lower Your Interest on Debt

You can lower DTI by decreasing your monthly payment amounts, even if you do not reduce your total amount owed. The easiest way to reduce your monthly payments is to refinance existing loans to lower your interest rate. Dropping the interest rate by just one or two percentage points can make a huge difference in your monthly payment, especially if the overall loan value is high. When using this method, consider refinancing car loans and consolidating credit cards into a single personal loan. 

4. Increase Your Income

If you want to boost your gross monthly income, consider getting a side hustle. You could deliver food, offer ride-sharing services, or make and sell crafts online. You will need to generate a consistent amount of income using your side hustle for 2 years before lenders recognize this additional revenue stream. Therefore, you should work on increasing your income soon so that you will be able to obtain the loan you need when you are ready to buy a home. 

Perhaps you are scheduled for a raise or promotion that will generate additional income.  Or it may be time to consider a higher paying position or company.

How to Calculate Your Debt-to-Income Ratio for a Mortgage

1. Gather Monthly Expenses:

Start by listing your relevant monthly expenses, such as rent, credit card bills, and car loans. Remember, do not include the cost of groceries, gas, utilities, childcare, commute, or health care/insurance.

2. Determine Your Gross Monthly Income:

Calculate your gross monthly income by dividing your annual gross income by 12 or by reviewing four weeks of your most recent pay stubs.

3. Calculate DTI:

Divide your monthly debt payments by your gross monthly income. This calculation should yield a number between zero and one — for example, 0.40. This number is your DTI. It can be expressed as a percentage if you multiply it by 100. In this example, your DTI would be 40%.

How to Get a Loan With a High Debt-to-Income Ratio

While most lenders want your DTI to be less than 50%, there are instances where you may qualify for a loan with a high debt-to-income ratio. For example, if you are self-employed, your W2s might not accurately reflect your true income. As a result, your DTI will appear unusually high even if you are in good financial health. Fortunately, you may still be able to qualify for a type of home loan by working with CrossCountry Mortgage. We offer several nontraditional mortgage options for individuals who might not be eligible for traditional mortgages.

If you would like to learn more about our flexible lending options and how we might be able to help you become a homeowner, connect with CrossCountry Mortgage's expert lending team today. 

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