Although your debt-to-income ratio is not one of the key factors that make up your credit score, a high ratio can affect your loan eligibility when you apply for a home mortgage refinance. Lenders use the ratio to determine if you are able to repay your current and new debts. A high ratio makes you more of a risk, which could get you denied for a loan or increase the interest rate you pay if you're approved. The good news is it’s something you can improve.
Figure your debt-to-income ratio before talking to a lender. This is how much money you spend each month as compared to how much you earn. Although lenders generally look at a borrower’s front-end debt ratio to determine credit worthiness, Realtor.com recommends calculating both your front-end and back-end debt ratios to see where you stand debt wise. To calculate your front-end ratio, divide your monthly housing expenses by your monthly income before taxes. Divide your monthly income by the total of your monthly debt payments to get you back-end ratio.
Reduce your debt-to-income ratio. While a high debt-to-income ratio itself won’t lower your credit score, owing too many debts can. How much debt you owe accounts for 30 percent of your credit score with scoring models putting more weight on revolving lines of credit like credit card accounts. Paying down debt is one way to improve your credit score; make extra payments to decrease high credit card balance and avoid taking on additional deb. You will be less of a credit risk if you can reduce your debt-to-income ratio below 20 percent, points out real estate and personal finance journalist Ilyce Glink in an article for Bankrate.com.
Find out if there are any federal programs to make refinancing more affordable. At the time of publication the Departments of the Treasury and Housing and Urban Development (HUD) offered various Making Home Affordable (MHA) programs. Talk to a HUD-approved housing counselor who can tell you what financial documents you will need to provide your mortgage lender when you apply. Contact your lender and ask if it participates in the federal Home Affordable Refinance Program (HARP); at the time of publication, this program expires December 31, 2015. You may be eligible for HARP if Freddie Mac or Fannie Mae owns or guarantees your mortgage loan, you’ve made your monthly payments on time for the past year and the current loan-to-value ratio is more than 80 percent. HARP may be a refinance option if you only have a small amount of equity in your home or your mortgage is underwater.
Inquire about a Federal Housing Administration (FHA) refinance loan. Although under FHA guidelines the maximum debt-to-income ratio to qualify for a home loan is 31 percent, you still may qualify. Some lenders will consider you for a loan despite a high debt-to-income ratio if you have a solid credit history and can show job stability over time.
- Realtor.com: Calculate Your Debt to Income Ratio
- Bankrate.com: Credit Do’s and Don’ts Before a Refinance
- Myfico.com: Amounts Owed
- Bank of America: Keeping Your Debt Load Manageable
- Myfico: How to Repair My Credit and Improve My FICO Credit Score
- Making Home Affordable.gov: Home Affordable Refinance Program
- FHA.com: FHA Requirements -- Debt Ratios
Amber Keefer has more than 25 years of experience working in the fields of human services and health care administration. Writing professionally since 1997, she has written articles covering business and finance, health, fitness, parenting and senior living issues for both print and online publications. Keefer holds a B.A. from Bloomsburg University of Pennsylvania and an M.B.A. in health care management from Baker College.