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Purchasing a home is one of the most significant financial decisions in a person’s life. When evaluating borrowers looking to secure a mortgage, lenders consider various financial factors, with debt-to-income (DTI) ratio being a critical component.
Because of the high debt held by many physicians, dentists and veterinarians, doctors can face challenges obtaining a mortgage loan. This can be particularly difficult for residents, trainees and early career doctors, who have low income or have just begun receiving a higher salary.
Understanding the relationship between DTI and mortgage approval is essential for potential homebuyers, as well as for those looking to refinance. In this article, we’ll explore what DTI is, how it influences doctors’ mortgage eligibility, and strategies to improve it.
What Is Debt-to-Income (DTI) Ratio?
Debt-to-income ratio is a financial metric used by lenders to assess an individual’s ability to manage their monthly debt obligations in relation to their income.
How Do You Calculate Debt-To-Income Ratios?
To calculate your debt-to-income (DTI) ratio, follow these steps:
1. Gather Your Monthly Debt Payments
Make a list of all your monthly debt payments. This includes items like:
– Monthly mortgage payment (if you have one)
– Minimum credit card payments
– Car loan payments
– Personal loan payments
– Student loan payments (minimum required/income based payments)
– Alimony or child support payments (if applicable)
– Any other monthly loan or debt obligations reported to your credit.
2. Calculate Your Gross Monthly Income
Add up all your sources of income that you receive on a regular basis. This can include:
– Monthly salary or wages (before taxes and deductions)
– Rental income
– Freelance or self-employment income
– Alimony or child support received (if applicable)
– Any other consistent sources of income
3. Divide Total Monthly Debt Payments By Gross Monthly Income
Take the total amount of your monthly debt payments and divide it by your gross monthly income. Then multiply the result by 100 to find the ratio as a percentage.
DTI Ratio = (Total Monthly Debt Payments / Gross Monthly Income) x 100
For example, let’s say your total monthly debt payments are $1,500, and your gross monthly income is $5,000.
DTI Ratio = ($1,500 / $5,000) x 100 = 0.30 x 100 = 30%
In this example, your DTI ratio is 30%.
What Is A Good Debt-To-Income Ratio?
A lower DTI ratio indicates that you have lower monthly debt obligations in relation to your income, which is generally considered more favorable to lenders.
A higher DTI ratio suggests that a significant portion of your income goes towards debt payments, which may raise concerns for lenders and potentially affect your ability to secure a mortgage or loan with favorable terms.
How Does Debt-To-Income Ratio Affect Mortgage Approval?
When you apply for a mortgage, lenders scrutinize DTI ratio to evaluate your creditworthiness and gauge the level of risk associated with lending you money. A high DTI ratio suggests that a significant portion of your income is already allocated towards debt payments, leaving less room for a new mortgage payment. This could be a red flag for lenders, as it increases the likelihood of defaulting on the mortgage.
Most lenders prefer borrowers to have a DTI ratio of 43% or lower (including the new mortgage payment) to qualify for a mortgage. However, some loan programs may allow a higher DTI ratio, but the higher it is, the more challenging it may be to secure favorable terms and interest rates. A lower DTI, on the other hand, is more likely to help you achieve favorable loan terms and lower interest rates.
Using the example above, where current monthly debts are $1500, and gross income is $5000, adding in a $1000 mortgage payment puts the total proposed monthly debt-to-income at 50% ($1500+$1000 / $5000 = .5 x100 = 50%). If a lender allows for total DTI to go up to 50% then your new mortgage payment cannot exceed $1000/month. Sticking with a 43% DTI limit allows for a new mortgage up to $650/month with the same scenario.
How to Improve Your Debt-To-Income Ratio
If you have a high debt-to-income ratio, the two main ways to improve it are to raise your income or lower your debt. Here are some tips:
Increase Your Income: Increasing income is one way to lower your debt-to-income ratio, but it can be difficult for doctors. With already demanding work schedules, taking on another job can be challenging time-wise or could lead to decreased mental health due to overwork and lack of down time.
Despite these possible challenges, 37% of physicians have a side gig, according to Medscape. Common examples of these secondary jobs include medical consulting, chart review, real estate and investing.
Reduce Outstanding Debts: If you’re not able to take on more work, lowering your debt load may be the best course of action for you. Start by tackling high-interest debts like credit cards and personal loans. Create a structured repayment plan to reduce outstanding balances, which will not only lower your DTI ratio but also improve your overall credit score.
Keep in mind that lenders typically use the minimum monthly payment when calculating your DTI ratio, not loan balances, so when tackling debt to free up DTI, it’s best to focus on eliminating or reducing higher monthly payment obligations…even if balances remain on those accounts.
It’s important to note that sometimes closing accounts with a long history, and in good standing, can actually lower your credit score, so talk to your lender before taking any action to close newly paid off accounts.
Avoid New Debt: Prioritize avoiding any new debt commitments while you’re in the process of applying for a mortgage.
Taking on new loans or credit lines can increase your DTI ratio and raise concerns for lenders—at minimum, the newly opened debts will need to be sourced and explained, at worst the monthly payment can put your DTI over the limit and suddenly disqualify you mid-transaction. For a smooth mortgage transaction, with limited surprises, avoiding opening new accounts is key.
Budget Wisely: Develop a detailed budget to track your monthly expenses and identify areas where you can cut back. By managing your spending prudently, you’ll free up more funds to pay off debts and improve your DTI ratio, and likely as a result, your credit score too. Find tips for budgeting here.
Consolidate Debt: Consider consolidating multiple high-interest debts into a single, lower-interest loan. Debt consolidation can simplify your repayment process and potentially reduce your monthly debt obligations. Learn more about consolidation here.
Increase Down Payment: A larger down payment can have a positive impact on your mortgage application. By reducing the loan amount, your DTI ratio will improve, increasing your chances of approval. We share more tips for down payments here.
Lower Debts & Put Less Down: Gone are the days where you need 20% to put down. Sometimes it can actually be better to allocate some of your funds towards debt reduction and put less down on your mortgage.
Compare both scenarios (20% down versus 5% down and debt reduction) to see which method gives you lower overall debts, and a comfortable monthly payment on your new home. Putting less down and reducing debts may also help you to qualify for more house too, increasing your leverage.
Be Patient: Improving DTI ratio and achieving financial stability takes time and perseverance. The journey to homeownership may involve some sacrifices, but the long-term benefits of owning a home can make it worthwhile.
Improving Your Debt-To-Income Ratio
Your debt-to-income ratio plays a crucial role in determining your eligibility for a mortgage. By implementing smart financial strategies, such as reducing debts and increasing your income, you can take control of your DTI ratio and move one step closer to achieving your homeownership dreams. Remember, responsible financial management is the key to unlocking the door to your new home.
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Disclosure/Fine Print
The information and advertised terms, including interest rates, are from Primis Mortgage Company (www.nmlsconsumeraccess.org NMLS# 1894879; Equal Housing Lender). Mortgage applications can only be submitted in those states that Primis Mortgage is approved to lend. Panacea Financial is not a mortgage lender in any transaction and does not make mortgage loans, mortgage loan commitments or lock-rates related to mortgage loans. All credit decisions for mortgage loans, including loan approval and the conditional rates and terms offered, are the responsibility of Primis Mortgage Company and will vary based upon the loan requested, the borrower’s financial situation, and criteria determined by Primis Mortgage Company. Not all consumers will qualify for the advertised rates and terms. All information provided is subject to verification. Other terms and conditions may apply. Panacea Financial does not guarantee that Primis Mortgage Company will make you a conditional loan offer and nothing herein or on this website is considered a commitment to lend. Panacea Financial is a division of Primis Bank and Primis Mortgage Company is a subsidiary of Primis Bank.
