Wednesday, July 27, 2022 / by Dave Magua
All About The Loan !
When you apply for a loan, like a mortgage, auto loan
or personal loan, lenders often want to know how
much debt you have compared to how much money
you earn. In other words, they want to know your
debt-to-income ratio.
Your debt-to-income ratio, or DTI, is a calculation of your monthly debt payments
divided by your gross monthly income.
Let’s take a look at how to calculate your debt-to-income ratio, learn why your
DTI matters, understand what a good debt-to-income ratio looks like and how to
lower your DTI ratio.
- How to calculate your debt-to-income ratio
- Why do lenders care about my debt-to-income ratio?
- When will lenders look at my debt-to-income ratio?
- What is a good debt-to-income ratio?
- How can I improve my debt-to-income ratio?
How to calculate your debt-to-income ratio
To calculate your DTI, add up the total of all of your monthly debt payments and
divide this amount by your gross monthly income, which is typically the amount of
money you make before taxes and other deductions each month.
Image: Graphic showing how to calculate debt-to-income ratio: divide monthly debt payments
by gross monthly income to get DTI
Let’s consider an example. Say your gross monthly income is $6,500 and your
debt payments total $3,000. Here’s how they break down.
Monthly bill Payment
Auto loan $500
Personal loan $400
Student loan $500
Credit cards $600
Mortgage $1,000
Total $3,000
Here’s how you’d calculate your debt-to-income ratio.
$3,000/$6,500 x 100 = 46.2%
Why do lenders care about my debt-to-income ratio?
When a lender considers whether or not to let you borrow money, it wants
information about how you handle your finances — both past and present. So
lenders will look at different factors — like your credit reports, credit scores and
debt-to-income ratio — to get an idea of your financial picture.
When lenders see a healthy debt-to-income ratio, it can help them feel more
confident that you’ll be able to make your loan payments. This might help you
qualify for financing.
When will lenders look at my debt-to-income ratio?
The process to borrow money differs depending on the type of loan and lender,
but in general, lenders want the most accurate picture of your finances they can
get before deciding whether to loan you money. This means that your debt-to-
income ratio may be part of their calculations.
Mortgages
It can be particularly helpful to know what your debt-to-income ratio is before
applying for a mortgage, because mortgage lenders often have strict DTI ratio
requirements.
Some mortgage lenders will only consider you for a mortgage if your DTI ratio
is under a certain percentage. According to the Consumer Financial Protection
Bureau, 43% is typically the highest DTI ratio a borrower can have to get a
qualified mortgage. On the other hand, some mortgage loans, such as FHA
loans, may allow a higher DTI ratio.
Personal loans and auto loans
With personal loans and car loans, you might be able to qualify for financing with
a DTI ratio higher than the typical 43% cap for a qualified mortgage. But you
should pay close attention to your interest rate and monthly payment to make
sure it’s affordable for you.
Wells Fargo, for example, says that if you have a DTI of 35% or less, you’re
probably in pretty good shape.
What is a good debt-to-income ratio?
A lower debt-to-income ratio is a good indicator that you’re able to take on more
debt and pay it off.
Keep in mind that any type of debt, including student loans, credit card balances,
auto loans, personal loans or mortgages, can increase your DTI ratio — as well
as costs like child support or alimony payments.
On the flip side, income from your job, along with any part-time or freelance work
and any alimony payments you receive, can count toward your gross income. So
it’s important that you keep track of all your debts and income in order to monitor
your DTI ratio.
How can I improve my debt-to-income ratio?
There are a number of ways you can try to improve your debt-to-income ratio.
The basic idea is lowering your debt or increasing your income. Here are some
ideas.
? Pay down debt early. If you have room in your finances, make more
than the minimum payments on your debts each month so that you pay
them down faster. For example, pay more than your minimum credit
card payment every month.
? Cut monthly expenses to pay off more debt. Look at your budget and
consider ways you can adjust your spending so that you have more
money to use toward debt repayment.
? Consider a debt-consolidation loan. If you can’t make extra payments
on your debt or trim your budget, a debt-consolidation loan could be a
good option. This may help you reduce the amount of interest you pay
while you work to pay down your debts.
? Get a side hustle or ask for a raise. Extra income from side jobs can
count toward your income when you calculate your debt-to-income ratio.
The boost in salary you’d get from a raise could also help to lower your
DTI.
What’s next?
Your debt-to-income ratio is an important number to know if you’re thinking about
applying for a loan or other credit.
If your DTI is too high, it can prevent you from getting the loan you want. But if
you can come up with a plan to reduce your debt or increase your income, you
can work on lowering your DTI, which might improve your chances of qualifying
for a loan.
