If you’re thinking about refinancing your mortgage, it’s important to understand your credit profile and how to make it as appealing to a lender as possible. Yes, this means you shouldn’t run out and buy that boat you’ve been eyeing or that designer purse that just hit store shelves. But, there’s more.
To make your application as attractive as possible, it’s important to have a good payment history, a reliable source of income, and a reasonable debt-to-income ratio. In fact, your debt-to-income ratio is one of the key components to a healthy credit profile. Do you know how to calculate it? And, if it’s unfavorable - do you know how to reduce it quickly?
Let’s take a deeper look at how your DTI is calculated, why it matters and what you can do to make it more attractive.
What is a Debt-to-Income Ratio?
Similar to your credit score, your debt-to-income ratio (DTI) is a metric that lenders use to help determine whether they will approve you for a loan and how much they are willing to lend you. Having a lower DTI increases your chances of getting approved.
DTI is calculated by taking your monthly debt payments, usually by adding the minimum payment amounts, divided by your monthly gross income: For example: If your total monthly debt payments equal $1,500 and your monthly gross income equals $8,000, you’d calculate your DTI with the following equation:
$1,500/$8,000 = 18.75% DTI
18.75% represents the amount of income that's being used to pay your debts. The lower your DTI percentage is, the better. The higher your DTI, the riskier the lender sees you and may not approve your loan or refinance.
The requirements for each bank will differ, but most lenders will approve loans with a DTI of 36% or lower; 36% being the ceiling of what they are willing to accept. Some lenders will approve loans with DTIs as high as 43%, but may require more funds at closing or at higher interest rates.
If you’re thinking about refinancing your home, it would be a good idea to calculate your DTI to get a general idea of what your lender will see.
If you've found yourself above a DTI of 35%, hope is not lost. There are still options; however, there many ways to help lower your DTI to get approved for your loan.
How to Improve your DTI
The good news is that there are always ways to improve your DTI. The general premise to improving your DTI is by increasing your income and/or decreasing your debt amount. Consider some of these tips below to help:
#1: Cut your Spending
Take a real look at where you're spending your monthly income, and if you're able to, adjust to save. Do you eat out every meal? If so, consider cooking more meals at home. Are you doing a lot of shopping? Skip buying those new TVs, iPods, and purses and instead, apply that money to an outstanding credit card or loan payment.
Chances are, if you review your spending carefully, you'll see many areas where you're able to save money and apply the extra funds toward paying down debt. Saving money here and there can make a huge difference, and you'll be surprised how much extra money you really have. Take a look at this for 18 ways not to spend money this weekend, by Budgetsaresexy.com for some great ideas.
You may also consider using cash to avoid using your credit cards. It's a lot harder to buy something unnecessary when you physically see the amount of cash you're using. And, you should also take another look at your monthly bills. Can you lower your cable bill? Maybe there's a promotion that you can take advantage of.
Moneysavingmom.com says, “Don’t get emotionally attached”, get rid of things that are no longer relevant or important to you. Consider selling items you have laying around that you aren't using. Do you have pieces of furniture in your garage or basement collecting dust? If so, have a yard sale or consider selling them online. Any money you make from the sale can be used to make a lump sum payment to one of your debts. You would be amazed at the amount of "stuff" you have collected over the years.
#2: Increase Your Salary
We know what you're thinking - isn't this your goal all the time? For some companies, annual reviews are performed to gauge an employee's work performance and - if they're doing a good job - are rewarded with some increase in their salary. Other companies that do not perform annual reviews may leave an individual unsure how they are doing and wondering if and when they will receive a pay increase.
The easiest thing to do is to ask. Are there new positions or training available to help move you into the next level in your career? Perhaps your boss was unaware that you were interested in advancing your career and would be happy to get you started on the right track. It is also possible that you should consider working for another company. Take a look at these 5 Keys to Job Promotions, Raises & Bonuses for some additional help.
Have you considered a part-time job or another source of income? Some people will search for another source of income working from home, after hours, or part-time. Even if some of the income could not be used as "income" towards your DTI, the money being made can be used for additional principal payments.
#3: Consolidate or Pay off Your Debt
Consolidating debt is an excellent way to reduce your monthly payment amounts. If you have five credit cards with a minimum payment of $50 each, that's $250 in minimum payments alone. If you're able to consolidate the debt into one payment, your minimum payment might be only $150 saving you an extra $100. Of course, the best thing to do would be to apply any additional funds to help pay down the balance quicker.
According to Wisebread.com, the fastest ways to pay off credit card debt include paying off the highest interest rate card first, not using your credit cards, setting a budget, and trying to make two minimum payments each month. You can even call your credit card companies to get your rate lowered. If you have a good payment history, many creditors will decrease your interest rate, allowing you to reduce the balance quicker. While this won't change your minimum payment, it can make a difference in the long run. There’s no harm is asking.
Once you’ve paid off your first credit card, don’t close the card. Keep it open, especially if you’ve had the card for a long time.
Mortgage Refinancing and Your DTI
We understand that these suggestions seem easy and that making these changes can seem overwhelming. But, when trying to improve your DTI, it's important to remember that there are only two major options: make more money or decrease your debt. You’ve must start somewhere.
If you're considering refinancing your mortgage and would like more information on how to quickly reduce your debt-to-income ratio, our team at Lenda is just a click away and is ready to help answer your questions. We offer more than just sound advice, but a chance to have a simplified and streamlined refinance process! Get a free quote today and let us help you start on the path.