Refinancing With a High Debt-to-Income Ratio
If you want to take advantage of historically low-interest rates but you’re balancing credit card debt, car loans, or student loan debt, you may be asking, “Can I refinance with a high debt-to-income ratio?”
Applying for refinancing with high debt-to-income is possible but may include a higher risk to the lender—which generally results in higher costs for the borrower.
Let’s take a closer look at what options are available and what lenders require in terms of debt-to-income ratio.
What’s the Maximum Debt-to- Income Ratio Be to Refinance?
Your debt-to-income ratio is a calculation of your monthly debt obligation divided by your gross monthly income (wages before any deductions are taken out) expressed as a percentage.
For example, if you earn $4,000 per month and your monthly debt payments total include $600 for an auto loan, a $500 student loan payment, and $500 towards credit card debt, your monthly loan payments total $1,600, and your DTI is 40% (1600 ÷ 4000 = 0.40).
Mortgage loan officers are looking for a debt-to-income ratio of no more than 43% for a conventional loan. However, lower DTI ratios can help you secure a lower interest rate on a mortgage refinance.
Does Debt-to-Income Ratio Affect Refinancing?
Your debt-to-income ratio is a significant factor in most types of refinance options. Along with credit score and mortgage payment history, the DTI ratio is a key statistic for lenders to determine whether you will be able to meet your debt obligations in a new loan contract. So, remember to check the debt-to-income ratio for second home or for the type of loan you want to get.
Debt-to-income ratios are usually judged in these ranges:
- Up to 20% – Borrowers in this range are considered excellent at managing their credit and debt. They’ll often have access to premium mortgage rates.
- 21% to 35% – You’re sitting pretty for a refinance if all your other information (credit score, mortgage payment history, gross monthly income) checks out—particularly if the amount of your monthly debt payments going toward your current mortgage(s) is no higher than 28%.
- 36% to 43% – You’re at the limit of what mortgage lender will accept for a qualified mortgage. Your refinance offer will likely include an interest rate above the current market rate.
- Higher than 43% – A traditional mortgage lender will probably turn you down for a refinance. You may be able to seek some nontraditional routes (see below), but your access to a qualified mortgage is limited. You may need to wait on a refinance and try to reduce your DTI ratio or look for refinance alternatives.
- Higher than 50% – Government-backed loans generally have a higher allowance for DTI ratios. Federal Housing Administration (FHA) loans, for instance, are available beyond the traditional 43% limit, but they max out at 50%.
What Happens if My Debt-to-Income Ratio Is Too High?
If your DTI is over 43%, you still have some alternatives available for a refinance mortgage with high debt-to-income ratio. However, keep in mind that a refinance is not just about being approved at all—it’s also about what rate a lender will offer you.
Borrowers with DTI ratios over 43% can attempt to refinance with:
- Non-qualified mortgages – Lenders have certain legal protections if they meet criteria that protect both their and the borrower’s interests. If they vary from these principles, they may still offer a loan that goes against industry standards, but beware of the fine print. A loan that does not meet qualified mortgage criteria can be a dangerous contract for both parties.
- Small creditors – Rules around offering a qualified mortgage differ for creditors who made no more than 500 mortgage loans and had under $2 billion in assets in the previous year. They may still be able to offer you a qualified mortgage with a higher DTI ratio if they feel you otherwise qualify to meet the loan requirements.
- Federal Housing Administration – The FHA can offer a mortgage to borrowers with a higher DTI ratio of up to 50%. Additionally, an FHA loan for bad credit offers borrowers to obtain a mortgage with a lower down payment. However, FHA loans require private mortgage insurance (PMI), which may negate savings you hope to see from your refinance. Unlike mortgage interest, PMI is not tax-deductible.
- Mortgage brokers – An independent mortgage broker is a helpful option when you don’t meet one or more of the traditional criteria for borrowing. With a network of lenders that include hard-to-place loans, a broker can help shop around for a lender that will work with you. But they aren’t going to provide an out-of-the-box alternative—read the fine print and be aware of the risks of non-qualified mortgages and high-rate offers.
When Does Debt-to-Income Ratio Not Affect Refinancing?
An outlier to this rule of thumb is for FHA and VA borrowers who already have a mortgage in good standing.
Streamline financing allows current mortgage holders to refinance at a new rate without going through the application process again. This means they rely on your original paperwork to weigh your ability to repay the loan—and therefore concede that you’ve already passed the DTI ratio test.
This type of refinance is available for:
- FHA borrowers through the FHA Streamline Refinance program
- Military homeowners through the Veterans Affairs (VA) Interest Rate Reduction Loan
Refinancing Alternatives for a High Debt-to-Income Ratio
If your debt-to-income ratio is too high for the refinance offer you were targeting, your action plan can go in a few different directions. You can:
- Seek a less desirable loan arrangement or lender (as detailed above)
- Reduce your DTI ratio
- Access your home equity
Next, we’ll detail your options.
Reducing Your Debt-to-Income Ratio
Your DTI is calculated with two monthly variables: how much money is being earned and how much is going out to repay debt. Shifting one or both of these variables may take time, but some actions can help you realize change in a matter of months rather than years.
Wondering how to lower debt-to-income ratio? These are just a few tips:
1. Increase Your Earnings
Without a magical wand to wave over your pay stub, increasing your earnings may seem like a challenge. Consider whether any of these approaches are accessible for you:
- Ask for a raise at your current job
- Discuss increasing responsibility and wages with your boss or HR department
- Work paid overtime hours
- Start a job hunt without leaving your current position
- Freelance in your current skillset by seeking contract work
2. Lower Your Monthly Payments
Once again, a magic wand would be a lovely asset to wave away debt, but in reality, there are ways to reduce your monthly loan payments. Start by keeping in mind that most lenders want to work with you to keep you making payments even at a lower amount—a lender’s worst outcome is a loan in total default.
The first step is always reaching out to lenders and explaining what your situation or goal is. Consider:
- Hardship plans – Creditors may have programs or practices in place to support borrowers with difficulty making payments, including waiving some fees or penalties for lowered payments for a set amount of time. Start by simply asking for a lower monthly debt payment and see what you can negotiate.
- Paying less for longer – You may be able to lower your monthly payment by increasing the length of a loan.
- Debt consolidation – If you have multiple credit card payments at higher interest rates, debt consolidation loans may help you replace your current payment structure with a single, lower monthly payment. At this point, you can see out a home equity loan for debt consolidation.
- Transfer balances – Look for a new credit card with a low introductory rate and a balance transfer offer as an alternative way to consolidate credit card debt into a single payment. Just be wary of the increased rate at the end of the promotional period.
- Student loan options – If you’ve ended up with multiple federal student loans, you can apply for debt consolidation. You can also apply for forbearance, income-based payments, or deferment based on unemployment or economic hardship. Some of these options are also available for private student loans.
Convert Your Home Equity Instead of Refinancing
Refinancing may seem like the best route to freeing up your financial resources. But if you have equity built up in your home, you have alternatives to risky loan arrangements that might add PMI payments to your budget.
A sale-leaseback program can provide an alternative solution to convert the equity in your house without the restrictive process of a traditional refinance application. Relying on your converted equity rather than your current credit score, DTI, and other hurdles allows us to work with you on a solution that recognizes what you’ve already proven with your mortgage payments over time.
If a sale-leaseback sounds like the best option for you, reach out to a financial expert to explore your options.
If you’re looking to refinance with a hight debt-to-income ratio, there are several requirements you need to make sure you consider. If you are still unsure after reading this article as to whether or not refinancing with a high debt-to-income ratio is right for you, consult a financial advisor to learn more .
- Nerdwallet. FHA Loan Requirements for 2022. https://www.nerdwallet.com/article/mortgages/fha-loan-requirements
- Consumer Financial Protection Bureau. What is a Qualified Mortgage? https://www.consumerfinance.gov/ask-cfpb/what-is-a-qualified-mortgage-en-1789/
- Consumer Financial Protection Bureau. What is a debt-to-income ratio? Why is the 43% debt-to-income ratio important? https://www.consumerfinance.gov/ask-cfpb/what-is-a-debt-to-income-ratio-why-is-the-43-debt-to-income-ratio-important-en-1791/