Getting approved for a mortgage is like running an obstacle course: There are lots of hurdles to overcome and you’ll probably be tired and a bit bruised at the finish line.
Frustratingly for many would-be home buyers, the race ends early because they have too much debt relative to their income.
Your debt-to-income ratio, or DTI, is the percentage of monthly income devoted to debts, including your future mortgage payment. Too much debt results in a high DTI — and it’s one of the most common reasons for mortgage denial.
While some research shows that borrowers with high DTIs are more likely to struggle with their mortgage payments, others argue that DTI limits have been too strict since the 2008 financial crisis. With higher debt limits, the Urban Institute, a nonprofit research organization, found that 95,000 more mortgages could be approved each year.
And we may soon find out which side is right.
Fannie and Freddie raise DTI ratio to 50%
Fannie Mae and Freddie Mac, two of the government-sponsored enterprises that fuel the home loan market, raised their debt-to-income limits in July 2017.
Now, certain borrowers with a DTI as high as 50% can get approved for a mortgage, up from the previous maximum of 45%. For DTIs over 50%, a loan that conforms to Fannie and Freddie’s standards is off the table, but a loan from the Federal Housing Administration — with the added cost of mortgage insurance — may still be in play.
That’s not to say your debt will be ignored. Be prepared for lenders to compensate for an elevated DTI in other areas of the application, like requiring additional cash reserves, a larger down payment and higher credit score.
“It’s better than the past where, for example, if you had a DTI of 48% or 47%, you wouldn’t get a mortgage,” says Karan Kaul, research associate at the Urban Institute. “Today you can, but you may need to have a slightly higher FICO score than someone with a lower DTI.” He says these compensating factors — a higher credit score, for example — help keep the default risk under control and make it safer for lenders to approve higher-DTI applicants.
Why are DTI limits changing now?
After the financial crisis of 2008, the mortgage industry “significantly overcorrected in terms of lending standards,” says Sheryl Pardo, senior communications manager at the Urban Institute. The housing market can expand to almost double its current risk levels and still be within “reasonable lending standards,” she says.
The Urban Institute’s Housing Credit Availability Index, which measures the percentage of home purchase loans that are likely to default, shows risk at historic lows for the past 10 years, Pardo says.
High-DTI homeownership isn’t right for everyone
Relaxed DTI requirements are especially good news for first-time home buyers, who tend to be younger, on the lower end of their earning potential and dealing with student debt, says Ray Brousseau, president of Carrington Mortgage Services.
The new limits may also empower black and Latino borrowers, who are more likely to have DTI ratios above 45%, according to the Urban Institute.
While you may have a better chance of getting a mortgage with the higher DTI limits, you should still be careful not to stretch your finances too thin.
“If you’ve got a high DTI, that’s an indication that you might be leveraged a little more than [a lender is] comfortable with,” Brousseau says.
“DTIs are kind of sterile,” he says. “They don’t take into consideration your standard of living and what it really costs to make ends meet.” He says a borrower with a higher DTI should make a monthly budget showing all expenses — not just those a lender is worried about — to see if they can afford a mortgage.
Consider how hard it would be to meet your mortgage payment if your partner lost his or her job or if you had emergency medical bills. If a high-DTI mortgage would leave you without much financial wiggle room, it may be best to postpone home buying until you’ve had a chance to reduce debt.
How to find a high-DTI mortgage
The DTI limits used by Fannie Mae, Freddie Mac and the FHA are guidelines, not a guarantee. Borrowers with high DTIs still have to find a lender willing to work with them.
Nonbank financial companies may be your best bet, Kaul says. These lenders, such as Quicken Loans and SoFi, don’t take deposits and are bound by fewer regulations than traditional banks. As a result, nonbanks are often more flexible when it comes to mortgage approval.