There’s a reason why you might get your mortgage application denied, even if you have a high income! Find out what it is!
If you’re planning to buy a house with a mortgage, getting your finances in order is essential if you don’t want your application to be denied. However, there’s one major factor that you need to look out for, and that is your debt-to-income (DTI) ratio.
Your DTI ratio measures your debt payments devided by your gross monthly income. According to the Consumer Financial Protection Bureau, it’s the top factor lenders use to evaluate whether you can handle monthly loan payments or not.
In fact, the 2024 Home Buyers and Sellers Generational Trends, reported by the National Association of Realtors (NAR), found that 48% of mortgage denials were due to high DTI ratios, making it the most common reason for rejection. Other issues included low credit scores (21%), unverifiable income (10%), and insufficient savings (16%).
Why Lenders Focus on a Healthy Debt-to-Income Ratio
For those who rely on borrowing, lenders carefully assess the DTI ratio to ensure you won’t struggle to add a mortgage payment on top of other debts. “The higher your debt-to-income ratio is, the less chance they’re going to feel comfortable lending to you”, said Clifford Cornell, a certified financial planner and associate financial advisor at Bone Fide Wealth in New York City.
This issue affects borrowers across all income levels. “If you’re a high earner, you might not experience an issue saving towards a down payment, but that doesn’t mean you have a healthy debt to income ratio”, said Shweta Lawande, a certified financial planner and lead advisor at Francis Financial in New York City.
How to Calculate Your Debt-to-Income Ratio
A “good” DTI ratio is typically 35% or lower, according to LendingTree. Knowing your DTI ratio is the first step before applying for a mortgage. Here’s how to calculate it:
- Add up your required monthly debt payments;
- Divide that total by your gross monthly income;
- Multiply the result by 100 to express your DTI as a percentage.
Strategies to Improve Your Debt-to-Income Ratio
Improving your DTI ratio involves either reducing your debt or increasing your income.
Paying Down Debt
There are two main strategies to tackle debt:
- Snowball Method: focus on paying off the smallest debts first, regardless of interest rates. This method can feel more motivating as you eliminate balances quickly.
- Avalanche Method: prioritize debts with the highest interest rates, which reduces the overall cost of borrowing and can help you pay off debt faster.
“Whichever one’s costing you the most to borrow is the one that you want to pay down as quickly as possible”, said Cornell. For instance, if you have a credit card with a 20% interest rate and a student loan with a 6% interest rate, it’s better to pay off the credit card first, he added.
Boosting Income
If you’ve already minimized or consolidated your debt, focus on increasing your income and avoid making large purchases that require new financing, as this could further impact your DTI ratio, advised Lawande. “The goal is to just preserve the cash flow as much as possible”, she added.