Can’t Get a Mortgage? Debt-to-Income Ratio, Explained

Pauline Millard
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At age 26, Liz Grimes felt like a bona fide adult. She had a stable job in public relations, owned her car outright and had a healthy savings account. She was ready to take another big step in life and buy a condo or a townhouse. “I figured I could live in it for a few years and then use it as an investment property,” she says.

Grimes applied for a mortgage at her bank in Albany where she not only does all her banking but also has a student loan. She was initially preapproved for $160,000. A few weeks later, though, she received a letter that said because of the $25,000 she still owes in student loans, she was declined for a mortgage because of a high debt-to-income ratio.

Grimes was shocked. “I pay more than the minimum payment on the student loans every month, have great credit, and my own bank wouldn’t approve me for a mortgage,” she says. She is now working with a mortgage broker and hoping a monetary gift from a relative will make her a more attractive borrower to lenders.

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The amount of money you owe versus the amount you bring home is called your debt-to-income ratio, or DTI. Your DTI is the percentage of your monthly gross income that goes toward paying debts. Generally speaking, you don’t want a DTI higher than about 40%. If your DTI is too high, lenders may worry you can’t afford to make the monthly mortgage payments.

Steep student loans, though, don’t have to be a roadblock to your American Dream. Carol Lynn Upshaw, vice president of Private Mortgage Services, a division of Private Bank of Buckhead in Atlanta, says that while lending practices may be stricter, there are ways you could get creative in order to secure a mortgage.

In fact, she says, in America it’s good to carry a little debt. It shows lenders that you are responsible when it comes to making payments, and that other people, be it a student loan company or a credit card, have already given you a line of credit. Of course, this advice comes with a few very important caveats:

1. Make sure you are paying the debts. There are a lot of myths about good debt versus bad debt, but the bottom line, Upshaw says, is that you need to make payments on all of your debt, every month. Even if you owe thousands of dollars on credit cards from your days as a student, as long as payments are being made regularly and on time, you’re off to a good start. A good credit score goes a long way when applying for a mortgage.

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2. Use a mortgage broker. One of the easiest ways to learn about your options as a borrower is to use a mortgage broker. A broker is especially important if you have dings on your credit report, or even a bankruptcy, a foreclosure or a short sale. A traditional bank may not be willing to give you a loan—because they are averse to risk, but brokers will know lenders who will work with less than perfect credit or first-time home owners.

“You’re going to pay a premium if there are historical issues on your credit report,” Upshaw says. “But there are solutions that a mortgage broker can find.”

3. Put one person on the loan. Depending on what state you live in, you only have to put one person on the loan, but both can be on the title of the property. If your partner has been working steadily while you were in school, for example, Upshaw suggests only having him or her apply for the loan. It may make the process a lot easier.

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4. Consider asking a parent to co-sign. You’re an adult and want to be independent, but sometimes having your parents co-sign a loan can get you approved. If your lender allows a non-occupant co-signer, this could be an option. Upshaw calls this option a “Band-Aid loan.” “It gets you into the home, and if you make the payments on time and are financially stable, you can refinance in two years.”

5. Don’t be afraid of ARMs. Adjustable rate mortgages got a bad reputation during the financial crisis, but Upshaw says that they can be another kind of “Band-Aid” to get you into a property. If you take on an ARM, “be smart and read the fine print,” she says. Plan to refinance, and be careful of balloon payments at the end of the loan, which is where a lot of people got tripped up during the financial crisis five years ago.

LearnVest Planning Services is a registered investment adviser and subsidiary of LearnVest, Inc. that provides financial plans for its clients. Information shown is for illustrative purposes only and is not intended as investment advice. Please consult a financial adviser for advice specific to your financial situation. The people quoted in this piece are not clients of LearnVest Planning Services.