Don't make the mistake of thinking you only need good credit and income to qualify for a mortgage—it takes more.
Your credit score says a lot about your credit habits, such as whether you pay your bills on time. You obviously need a steady job and sufficient income to support a monthly mortgage payment, but the mortgage lender will also evaluate your debt before approving your application. And unfortunately, too much consumer debt can bring your loan to a screeching halt.
Debt-to-income ratio refers to the percentage of monthly income that’s used to pay debt. When applying for a mortgage loan, lenders look at an applicant’s front-end ratio and back-end ratio. The front-end ratio, also called the housing ratio, is the percentage of your gross monthly income used to pay the mortgage. The back-end ratio is the percentage of total minimum debt payments (including the mortgage payment) in relation to gross income.
You might think your debt isn’t a big deal, especially if you pay on time. What you may fail to realize is that too much debt can ruin your chances of qualifying for a mortgage. Lenders don’t expect applicants to have zero debt. But they do expect a reasonable level of debt.
Typically, your front-end ratio should be no more than 28% to 31% of gross monthly income, depending on the type of mortgage. Total debt payments, or the back-end ratio, should not exceed 43%. Some people apply for a mortgage with confidence, so being rejected because of debt often comes as a chock. From a lender’s standpoint, excessive debt strains an applicant’s budget. And when applicants are overextended, there's a higher risk of default.
Being rejected for a mortgage can put a black cloud over your day, week or month, but a high debt-to-income ratio is fixable. Here are some of the best strategies for improving your ratio and qualifying for a mortgage.
1. Pay off credit cards and loan balances
If your mortgage lender won’t approve a loan because of debt, paying off credit cards and loans is one of the quickest ways to get your application approved.
Sometimes, applicants are rejected because their debt-to-income ratio is slightly over the percentage allowed by the lender. Paying off credit cards or loan balances can free up cash in your budget, which can help you qualify. Just make sure you check with the lender first. While paying off debt can improve your debt ratio, it can also drain your cash reserve, and you may not have enough money for your down payment, closing costs and other mortgage-related expenses.
2. Apply with a joint applicant
Some heads of households apply for a mortgage in their name only. But if there’s too much debt, the lender may reject his application until he pays off balances or increases his income.
Since income isn't something we can increase overnight, you might make headway by adding your spouse to the mortgage application, even if he or she only works part-time. The lender will calculate your combined income, which can result in an overall lower debt-to-income ratio— providing your spouse doesn't have too many of his or her own debts.
3. Seek new employment
Changing jobs during the lending process is dangerous, especially since lenders prefer at least 12 months of consistent income. But if you switch jobs and remain in the same field and earn the same salary or more, you shouldn’t have any issues finalizing the loan. Therefore, if you can't qualify for a particular amount because of a higher debt ratio, getting a job that pays considerably more can reduce your ratio and help you qualify.
If your gross annual income is $45,000 or $3,750 a month, based on your existing debt the lender may conclude that the most you can spend on a mortgage payment—including principal, taxes and insurance—is $1,050. Since this limits how much you can spend on a property, you might not qualify for homes with a higher price range. But if you found a new job earning an additional $10,000 a year, the lender may say you qualify for a mortgage with a payment of $1,283, giving you wiggle room to buy a more expensive home.
4. Get rid of a car loan
You may not have a lot of credit card debt, but an expensive auto loan payment can have a tremendous impact on how much you're able to spend on a property. You can also improve your debt-to-income ratio by getting rid of an expensive auto loan and buying a cheaper car.
Let’s say you’re paying $600 a month for your car. Eliminating this loan can potentially free up $600 in your budget—money that can be used to qualify for a mortgage loan. Maybe you can purchase a car and only pay $300 a month. It’s a win-win. You’ll still have transportation to get from point A to point B, yet a cheaper auto loan expense can improve your debt ratio and help you qualify for a mortgage faster.
Interested in what your financial profile might look like? Take a look here: