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Mortgage rates remain near historic lows, with some 30-year rates near 3% and some 15-year rates near 2%, as you can see here — though experts predict they will rise. But you might not get a mortgage at all, if you fall into some of these traps: According to a recently released NerdWallet report that looked at mortgage application data from 2020, 8% of mortgage applications were denied, and there were 58,000 more denials in 2020 than 2019 (though, to be fair, there were also more mortgage applications). The No. 1 reason for those denials? An unfavorable debt-to-income ratio (DTI), which was responsible for 32% of all denials. “The debt-to-income ratio is historically the top reason for denials, it was in pre-pandemic 2019 too,” explains Elizabeth Renter, data analyst at NerdWallet. That was followed by a low credit score, which was the No. 2 reason and was responsible for 26% of denials. Here’s how to avoid the DTI trap.
What is a debt-to-income ratio and how do I figure out mine?
So what exactly is DTI? It’s simply your monthly debt payments (mortgage; credit card payments; auto, student or personal loans; child support, etc.) divided by your gross monthly income. And most lenders want you to have a DTI ratio that is ideally at or below 36%, though this depends on the lender, type of loan and other factors. If your monthly debt equals $2,500 and your gross monthly income is $7,000, your DTI ratio equals about 36% ($2,500/$7,000=0.357).
Why does your DTI matter so much?
As for why mortgages are being denied because of DTI ratios, Renter says: “This is because DTI is a solid risk indicator. If you have too much debt or not enough income, a lender sees you as a risk, after all, how will you add a mortgage payment and additional homeownership expenses onto an already stretched budget.”
What to do if you’re denied a mortgage because of your DTI
If your DTI ratio is above 36%, don’t despair. Renter says reducing your monthly debt payments and increasing your income are two ways you can improve your DTI. “Tackle high-interest debt like credit card debt first and then move onto things like personal and auto loans. The benefits of paying off debt goes beyond lowering your DTI and potentially raises your credit score and frees up discretionary income,” says Renter.
Adds Greg McBride, chief financial analyst at Bankrate, of getting a mortgage denial because of a high DTI: “You have too much debt and not enough breathing room in your budget. Focus on boosting savings, this acts as a buffer from incurring debt in the future when unplanned expenses arise.”
Bottom line: “Lenders aren’t denying mortgages for high DTIs just to be difficult, and lowering your DTI will truly make your finances — and life — more manageable long-term,” says Renter.
What other factors impact my ability to get a mortgage?
A low credit score can mean you get denied for a mortgage, so review your credit report regularly to ensure there are no errors and that you know what’s happening with your score, says Renter. “[Lenders] want to see a history of on-time payments and positively resolved accounts,” says Renter. They also prefer a high score: Jacob Channel, LendingTree’s senior writer, says lenders like to see scores at or above 760 before offering their most competitive rates. If your credit score is lacking, making payments on time, paying down revolving debt and considering a program like Experian Boost, which can push you over the hump if you’re close to the threshold, can all help increase your score.
“In addition to your debt ratio, your credit score, income, cash reserves and down payment will come into play in getting approved for a mortgage,” McBride says.