Mortgage rates remain near historic lows but will probably rise in 2021. But even with a mortgage rate in the 3% range, there are traps to be avoided if you want a mortgage at all. Primary among these traps is the debt-to-income ratio (DTI). A recent study by NerdWallet showed that application data from 2020 indicated that 8% of mortgage applications were denied. An unfavorable DTI was the reason for the denial 32% of the time. Low credit scores were the reason for denials 26% of the time. Here’s how to sidestep the DTI trap.
What is a DTI ratio, and how do I calculate mine?
l and student loans; child support; alimony; mortgage; credit card payments, etc.) divided by your gross monthly income. And most lenders want you to have a DTI ratio that is ideally at or below 36%, though this depends on the lender, type of loan, and other factors. If your monthly debt equals $2,500 and your gross monthly income is $7,000, your DTI ratio equals about 36% ($2,500/$7,000=0.357).
Why does your DTI matter so much?
If you have too much debt, lenders see you as a risk. If your budget is already stretched, adding to it with a mortgage would create a higher risk from the lender’s perspective.
If you’re denied a mortgage because of your DTI, here’s what to do
If your DTI ratio is above 36%, don’t lose hope. Increasing your income and reducing your debt can improve it. Paying off credit cards and personal loans should be your priority. Next, work on auto loans and personal loans. Not only will paying off debt improve your DTI, but it will also give you more discretionary income.
Boosting savings should also be a goal as it acts as a buffer from incurring debt in the future when unplanned expenses come up.
Lenders are not trying to be difficult when denying mortgages based on DTI; most will even tell you how to improve your score to qualify. Bottom line: Lowering your DTI will significantly impact your life and your finances.
Other factors to consider to get a mortgage?
A low credit score can get you denied a mortgage, but it’s not the most prevalent reason lenders refuse a mortgage. Review your score regularly and look for ways to improve it. A credit score above 760 may help you qualify for the most competitive rates. Paying off debt and on-time payments are two sure ways to improve your credit score.