Debt-to-income, or DTI, requirements for refinancing a mortgage are very similar to when you originally went through the approval process. Depending on your loan program, your DTI should be no higher than about 43-50% of your gross income. But a lot depends on your situation, so let’s take a closer look.
The least you need to know:
- Your Debt-to-Income ratio is the percentage of your total income that goes toward debt payments.
- A lower debt-to-income ratio can help you receive a better interest rate on your mortgage.
- Most lenders consider a debt-to-income ratio under 43% to be good.
How To Calculate DTI
DTI is a formula lenders use to compare your current monthly housing and debt payments to your gross monthly income. This helps lenders assess your ability to repay the loan.
Here’s a formula for DTI:
(Total Housing Payment + All Payments on Debt) / Gross Income = DTI
For example, you have a $2,500 house payment including principal, interest, taxes, insurance, and dues. Your monthly payments on credit cards, student loans, and auto loans is $1,000. Your before-tax income is $8,000. Your DTI would be 43.7%.
($2,500 + $1,000) / $8,000 = .437 or 43.7%
If your finances are relatively the same today as when you first took out your mortgage, your DTI should be in good shape. However, if you have more credit card debt or a new auto loan, understanding your current DTI and how it can affect your ability to refinance will be necessary.
Front-End DTI and Back-End DTI
Lenders look at two types of DTI. Your front-end DTI is your total house payment versus income. Your back-end DTI compares your housing payments and debt payments to your income. Throughout this article, we’ll mostly be talking about back-end DTI.
What DTI Do You Need to Refinance?
“Most lending decisions include a review of your debt-to-income ratio or DTI,” said Felton Ellington, Community Lending Manager at Chase Home Lending. “This is a basic calculation that considers what percentage of your gross monthly income goes toward paying debts. Generally, you want to try to keep your DTI under 36% which could increase your chances of qualifying for a loan. This is a basic safeguard that lenders put into place to help ensure that the mortgage would be sustainable and that the customer doesn’t end up being house poor.”
Here’s a look at the requirements for several different types of loans.
DTI Requirements for Conventional Refinances
If you plan to refinance with a conventional loan, the ideal back-end DTI will be around 36% for both rate-and-term and cash-out refinances. Staying below this level will help you get the best interest rates on your loan. However, some lenders will still approve loan applications with a DTI in the 45% to 50% range if you have a strong credit profile or significant savings.
DTI Requirements for FHA Refinances
If you’re applying for an FHA streamline refinance, you probably don’t need to worry about DTI at all. That’s because the streamline option doesn’t require income verification. Without income, no DTI can be calculated. So even if you have higher debts or lower income than when you purchased the home, you may still qualify for FHA.
However, some FHA refinances, including a few streamline options, may require income verification. In these cases, lenders will consider both your front-end DTI and back-end DTI.
FHA lenders want a front-end DTI of no more than 31% and a back-end DTI that doesn’t exceed 43%. However, just like with conventional loans, lenders might still approve an application for someone with a higher DTI if they have a strong credit score or significant cash reserves.
In fact, a few applicants have seen approvals with DTIs as high as 56.9% on a FHA loan, but those are rare cases.
DTI Requirements for USDA Refinances
Similar to FHA, USDA offers a streamline option that may not require income or DTI verification.
However, some USDA refinances will look at both front-end and back-end DTI. USDA lenders traditionally want a front-end DTI of no more than 29% and a back-end DTI of no more than 41%. However, a higher back-end DTI of up to 43% could be considered if you have a strong credit score and at least three months’ worth of housing payments in savings.
DTI Requirements for VA Refinances
Most refinances through the VA home loan program will not require income verification or a DTI calculation. However, if you’re seeking VA cash out or refinancing into a VA loan from another program, DTI will be required.
In these cases, lenders will want a back-end DTI below 41%. However, depending on your credit profile, you might be approved with a DTI as high as 50%.
How to Improve Your DTI
If your DTI is pushing the upper limits, the best thing you can do is improve it before applying to refinance. Here are a few tips for how to improve your DTI.
- Increase your income: One way to lower your DTI is to increase your income. However, this will need to come via a raise in your W2 job or a higher-paying job with another employer. Getting a side gig or second job won’t help your DTI since this is not qualifying income until you’ve been doing it for at least two years alongside your day job.
- Pay more than the minimums: If you have credit card debt, try to pay more than the minimum payment each month. This will help you reduce your debt faster, improving your DTI.
- Set up a repayment strategy: While paying more than the minimum credit card payment each month will be helpful, you should have a larger debt repayment plan in place. Two common strategies are the debt snowball and the debt avalanche methods.
- Consolidate your debt: With average credit card interest rates over 21%, finding ways to lower your debt payments can help you pay down your balances faster. Consolidating your debt with a lower-interest personal loan can also help improve your DTI.
- Use a balance transfer credit card: Balance transfer credit cards are another great way to reduce your credit card debt quickly. Some offer an introductory 0% APR for up to 21 months. While keeping the same monthly payment, these cards allow you to pay your balance much quicker.
- Reduce monthly expenses: If you have significant debt, look for ways to reduce your monthly expenses. You could cancel your streaming services, shop around for less expensive car insurance, and cut out unnecessary expenses.
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