How to Calculate Debt to Income Ratio for Refinancing

Lenders are being hit with a flood of mortgage refinance requests as the coronavirus is sending rates lower, according to the WSJ. Rates for refinances in March 2020 are near 4% and many want to take advantage to snag a lower monthly payment.

Homeowners who want to pull the trigger on a refinance need to know a few things, such as their debt-to-income ratio (DTI). Your DTI is one of the factors that determine if you can refinance, as well as the interest you will pay.

Below is everything you need to know about debt-to-income ratios and refinancing your mortgage.

Overview of Debt-to-Income Ratio

Your DTI divides the total of all your monthly debt payments by your gross monthly income. Lenders use your DTI and credit history to determine if you can get a loan and what your rate will be. Each mortgage lender sets its own DTI requirements.

To calculate your DTI, just add up what you owe each month, such as rent or mortgage, credit card minimums, student loans, etc. Then, you divide that number by your gross monthly income (before taxes are taken out).

For example, say you have a mortgage payment of $1,000, a $300 car payment, a minimum credit card payment of $200 and a gross monthly income of $6,000.

Your DTI is 25%, which most lenders consider low. Depending on your credit score, you have a good shot at getting a good rate on a mortgage refinance.

However, if you have a lot more debt, you could have a DTI of 35% or 40%. The Federal Reserve states that a DTI of 40% or higher may be a sign of financial distress. You might still be approved for a refinance, but the lender may charge you a higher interest rate.

How Your Lender Views Your Debt-to-Income Ratio

Mortgage lenders prefer borrowers with a lower DTI because research shows that homeowners with a higher DTI are more likely to default.

Every mortgage lender has the right to set its own DTI requirements.

Generally, a 43% DTI is the highest that most lenders will accept for mortgage approval.

If your DTI is above 40%, you may not be able to qualify for a refinance. However, some personal loan companies may lend you money with a DTI of 50% or more. Some personal loan providers will exclude mortgage debt from their calculations. If you need to consolidate credit card debt and cannot refinance, consider trying for a personal loan.

What To Do If Your Debt-To-Income Ratio Is Too High

First of all, keep in mind that your DTI is very important when you apply for a refinance. Most lenders favor applicants with a lower DTI than those with a higher income.

You could have an income of $20,000 per month and a high DTI and be turned down for a refinance. Meanwhile, someone with a $5,000 income and a low DTI may be easily approved. That’s how lenders work.

If you have a high debt-to-income ratio, below are some ways to improve your odds of getting a green light from the lender:

#1 Try a Program With More Lenient Standards

Different mortgage programs have different DTI limits. For instance, Fannie Mae has a maximum DTI of 36%. However, the maximum can be increased to 45% if you meet credit score and cash reserve requirements.

But FHA loans may allow a DTI of up to 50% in some situations. You also do not need to have a high credit score to qualify; some people can qualify for an FHA cash-out refinance with a 620 credit score.

#2 Restructure Debt

You may be able to lower your DTI by restructuring debt. Some people get a mortgage refinance to put their high-interest personal debt into a lower-rate mortgage.

But to qualify for the refinance, you might consider restructuring your student loan into a longer-term plan. Or, pay off 20% interest rate credit cards with a 10% personal loan. Another option is to refinance your car into a longer term or lower rate.

If you can qualify, transfer credit card balances to a new card with a zero percent introductory rate.

#3 Pay Down Certain Credit Accounts

If you have a car loan, try to pay that account down to fewer than ten payments. If you can, lenders may drop that payment from your DTI.

Or pay down your credit cards as much as possible. But to get the most bang for your reduction buck, take every balance on your credit cards and divide them by their monthly payments. Pay off the ones with the highest payment-to-balance ratio.

Say you have a credit card with a balance of $500 and a $45 payment. That is a 9% payment-to-balance ratio. You also have a credit card with a $3,000 balance and a $150 payment. That is a 5% payment-to-balance ratio. Pay off the $500 balance first.

Final Thoughts on How to Calculate Debt to Income Ratio For Refinancing

Getting your DTI as low as possible is a critical factor to get a mortgage refinance. If you are having problems getting approved, make sure you try the strategies we mention above.

Also, some lenders still may consider you if your DTI is 43% or higher. A smaller lender with assets under $2 billion must still look at your DTI, but they may approve you if your credit score is high enough.

The most important thing is to shop around. Try a few lenders to see if you can get approved for your refinance. Each lender has different requirements, so keep trying and you could get a great rate on your mortgage refinance.

References

Author: Bryan Dornan

Bryan Dornan is a financial journalist and currently serves as Chief Editor of Cash Out Refi Tips.com. Bryan has worked in the mortgage industry for over 20 years and has a wealth of experience in providing mortgage clients with the highest level of service in the industry. He also writes for RealtyTimes, Patch, Buzzfeed, Medium and other national publications. Find him on Twitter, Muckrack, Linkedin and ActiveRain.

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