If your debt-to-income, or DTI, ratio is too high, your mortgage loan may not be approved. Conventional loans require a DTI no higher than about 45-50%, and FHA loans top out at about 56%
But what if your DTI is above these levels?
Luckily, there are ways to reduce your DTI by strategically eliminating monthly debt payments.
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You Can Eliminate Monthly Debt from your DTI?
Lenders allow you to remove debt payments from your debt profile under certain conditions. This can help you qualify for a loan.
For example, you apply for a conventional loan and your maximum DTI is 45%.
Your lender notes a high payment but low balance on your auto loan. Suddenly your loan application switches from “denied” to “approved” by removing your auto loan payment.
No Payment Eliminated | Payment Eliminated | |
Income | $8,500/mo | $8,500/mo |
Full house payment | $3,000 | $3,000 |
Student loan | $500 | $500 |
Auto loan payment | $700 | $0 |
DTI | 49% | 41% |
Here's how that could happen.
The 10-Payment Rule
Lenders can disregard installment debt that will be paid off within 10 months. Installment debt is also known as closed-end: debt that started at a fixed amount and paid off in installments, such as auto loans and student loans.
In the example above, a $700 car payment would not be included in your DTI if the balance were $7,000 or less.
What’s more, conventional loans allow you to pay down the balance to the 10-month payoff level. In the above example, you could pay a $10,000 auto loan balance down to $7,000 and eliminate the debt from your DTI.
FHA differences:
FHA loans have the same 10-payment rule. However, you can’t pay down the balance to the 10-payment mark. Additionally, the payment has to be five percent or less of qualifying income.
For example, the credit report shows a student loan payment of $400 and a balance of $2,400 (six payments). The borrower’s income is $8,000. The debt may be eliminated on an FHA loan because the payment is five percent of gross income.
Tip: With all loan types and all debt elimination techniques, the underwriter can add back in the debt payment. Fannie Mae says, “The borrower’s history of credit use should be a factor in determining whether the appropriate approach is to include or exclude debt for qualification.”
Someone Else Makes the Payment
Another way to eliminate debt is to prove that someone else has been making the payment.
Conventional loans allow non-mortgage debt such as auto loans, student loans, credit cards, and leases to be eliminated from your DTI.
Mortgage-related debt can also be eliminated if:
The person making the payments is also obligated on the loan
There are no late payments in the last 12 months
No rental income from the property is being used to qualify
For debts paid by others, supply 12 months of bank statements or canceled checks showing consecutive, on-time payments from someone else.
Paying Off Credit Card (Revolving) Debt to Qualify
Surprisingly, you can pay off credit card balances to eliminate the minimum payment from your DTI.
For example, you have five credit cards, each with a $100 balance and $25 minimum payment. That’s $125 per month added to your debt ratios.
A good use of $500 is to pay off all these cards and show your lender updated statements, each with a $0 balance. The $125 cumulative payment can be removed.
What’s even more surprising is that you may not have to close the accounts.
Conventional (Fannie Mae and Freddie Mac): Revolving accounts need to be paid off but do not need to be closed
Government (FHA, VA, USDA): Revolving accounts must be paid off and closed
Pay Off Debt at Closing
You can pay off most debts as part of the closing to reduce your DTI level.
The lender will approve the loan subject to paying off, and usually, closing the debt as part of the loan settlement.
For example, the lender will add a funding condition that debts X, Y, and Z be paid off and closed through escrow. This means the escrow company will require extra funds from you at closing. The escrow company is then responsible for sending the funds to each creditor along with a request to close the account.
No, the lender will not trust you to pay off the accounts yourself after closing.
Keep in mind that this method will require you to prove extra assets. Your minimum required funds will rise. If you’re short on documentable cash, this strategy may not work.
2024 FHA Eligibility: Easy Online Process Built for First Time Buyers.
Verifying Debt Payoff Funds
The lender will need to verify where you got the money to pay off a large debt.
If you have cash in your mattress, don’t use it to pay off debts. You can’t document the source.
Until you prove otherwise, the lender will assume you borrowed money (created an undisclosed debt) to pay off other debts.
Make sure your debt payoff funds are coming from valid sources before you pay anything off.
Debt Elimination: Secret Weapon to Reduce DTI
With prices and mortgage rates as high as they are, sometimes you need every strategy available to lower your DTI.
Examine your debt payments and balances. Target installment debts with large payments but small balances. Can you pay off or pay down any enough to eliminate them from your DTI?
Request help from a lender, who can look at your credit and debt profile and make suggestions.
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About The Author:
Tim Lucas spent 11 years in the mortgage industry and now leverages that real-world knowledge to give consumers reliable, actionable advice. Tim has been featured in national publications such as Time, U.S. News, MSN, The Mortgage Reports, and more.
