For the past year, my husband and I have been concentrating on paying off our debts in anticipation of a mortgage refinance on a rental property we own. Paying down our consumer debt such as credit cards and medical bills not only improves our credit score, it also improves our debt to income ratio.
What is a debt to income ratio
A debt to income ratio (DTI) is a financial tool that compares a consumer's debt to the amount of income they earn. Banks use this information to determine how likely a consumer will be able to repay a loan. To calculate the DTI, lenders total up the minimum monthly payment of all your consumer debt (house payments, credit cards, etc) and then divide that number by your gross income to determine the ratio. If the ratio is under 40%, the borrower is considered a good risk for a refinance or home mortgage. Over that number and you can forget about getting a home loan.
My husband and I knew about the 40% cap on debt which is why we've worked extra hard this year to pay down as much debt as possible. By working harder and saving more, we were able to pay off a couple of medical bills and reduce our consumer debt by nearly $8000. This brought our DTI ratio to 34%.
The consumer debt we didn't count on
As we started the process of our refinance, there was one debt our lender included in our DTI ratio that completely caught us by surprise. This debt wasn't a real bill at all but simply an estimate of anticipated monthly home maintenance and repairs which was tacked onto our monthly expense sheet. The effect of adding this number into the equation increased our debt to income ratio to 39% which is a mere point away from a denied loan.
In our situation, the increased DTI ratio did not affect our ability to qualify for a loan refinance. If it had been higher, we would have switched lenders since not all banks include this expense when qualifying a borrower for a loan.
For borrowers whose debt to income ratio is in the mid 30s or lower like ours, including repairs and maintenance probably won't affect your ability to refinance. Consumers who are pushing the DTI limit however should be aware that some banks do include this expense which is why it's a wise idea to shop around before committing to a single lender.
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More by this contributor:
- Financials Industry
- debt to income ratio
- consumer debt