If you have one or more credit cards, student loans, car loans or any other form of debt, chances are your life is heavily impacted by your debt-to-income ratio (DTI) whether you know it or not. When applying for a mortgage, debt-to-income ratio is a key factor that lenders use to determine your mortgage eligibility. If you’re hoping to qualify for a mortgage, it’s important that you know about your debt-to-income ratio and then you can work to improve it.
Here’s everything you need to know about your DTI:
What Is Debt-To-Income Ratio?
Debt-to-income ratio is the percentage of your gross monthly income that is spent on monthly debt payments. These payments include credit cards, student loans, car loans, child support and mortgage payments. Your debt-to-income ratio, like your credit score, impacts your ability to qualify for a loan, such as a mortgage, from any kind of lender.
If you’re worried that your DTI might be too high to qualify for a loan, don’t worry. It’s possible to improve your debt-to-income ratio. We’ll talk more about that later.
Debt-To-Income Ratio Calculator
Your debt-to-income ratio compares how much money you owe per month to how much money you earn per month. Figuring out your debt-to-income ratio is not as difficult as it may seem. Use the information below to calculate what your DTI is.
Step 1: Add Up Your Fixed Monthly Debts.
These expenses may include:
- Monthly rent or house payment
- Minimum monthly credit card payments
- Student, auto and other monthly loan payments
- Monthly alimony or child support payments
- Other debt
Other payments like groceries, utilities, gas and taxes are typically not included in the DTI calculation.
Step 2: Divide By Your Gross Income (Income Before Taxes).
Sources of income can include:
- Tips and bonuses
- Social security
- Child support and alimony
Step 3: Convert Your Answer To A Percentage.
The final result is your debt-to-income ratio!
Let’s do an example. Pretend you have a rent of $1,000, a car payment of $400, a minimum credit card payment of $150 and a gross monthly income of $5,000. Your debt-to-income ratio is $1,550 divided by $5,000, which equals 31%. It’s important to note that the lower your DTI, the less risky you are to lenders.
How to calculate your debt-to-income ratio:
Why Your DTI Is So Important
Your DTI is important because it helps lenders determine your mortgage eligibility and the likelihood you will repay a loan.
Just like your credit score, your DTI significantly affects your financial health and possibilities for qualifying for a mortgage or taking on more debt. For example, if you were applying for a store credit card and had a DTI of 60%, your credit card interest rates would be high because your DTI is high. If your DTI was 40%, your interest rates would be in the middle, and if you had a low DTI of 15%, your interest rates would be low.
Typically, a good debt-to-income ratio is 35% or less. You can still qualify for a loan with a DTI ranging from 36% to 49%, but if your DTI is 50% or greater, you should take action to improve it.
Debt To Income Ratio For A Mortgage
When qualifying for a mortgage, it’s also important to have a good debt-to-income ratio.
Generally, in order to qualify for the most mortgage loan options, you should have a debt-to-income ratio that’s no greater than 43%. However, it’s important to note that mortgage qualification is based on a variety of factors including loan type, down payment, housing expense ratio and credit score.
If you’re looking to get a mortgage, DTI is just one of the words you’ll hear. Make sure you understand all the important terms related to your mortgage process, and know which questions you should ask your mortgage lender.
How To Improve Your Debt-To-Income Ratio
If you are looking to improve your DTI and increase the chance of getting a better interest rate, here are some tips:
Step 1: Increase Your Monthly Payments Toward Existing Debt.
If you can increase your monthly debt payments instead of paying the minimum monthly payment, your debt will get paid off faster and your debt-to-income ratio will decrease. If paying more than the minimum payment is too tight on your budget, start with a small raise and try to increase your income too. Although nobody wants to spend their extra money paying off debt, making payments greater than your minimum monthly debt payment will also help you save money in interest in the long run.
Step 2: Reduce Credit Card Charges.
Another strategy to reduce your debt-to-income ratio is to reduce your credit card charges or ditch your card altogether. Fewer expenses on your credit account will cut payments that you have to make in the future. Go old-school and try to use cash for expenses like food and clothes. Limiting your spending to cash purchases can also help you save money on daily purchases to put towards paying off debt. This strategy is interest-free and hopefully will help you with your budgeting skills!
Step 3: If Possible, Postpone Additional Loans Applications.
When you’re working hard to pay off current debt that’s is damaging your DTI, taking on new debt might make it worse. If you can, work to improve your debt-to-income ratio before opening a new account. When you do choose to apply for a loan, a better DTI can help you qualify for lower interest rates and better loan terms. So, improve your debt-to-income to save money when you take on more debt!
Improve your debt-to-income ratio in a few simple steps
To recap, your debt-to-income ratio is the percentage of your gross monthly income that is spent on monthly debt payments. It’s important because lenders use it to determine if you qualify for a mortgage or other type of loan, and what your interest rate and loan terms will be.
You can calculate your debt-to-income ratio by dividing your total monthly debt by your gross monthly income. When you calculate your DTI, it’s important to include the minimum monthly payment of each of your fixed monthly debts including mortgage or rent payments, car payments, student loan payments, credit card payments, alimony payments and child support payments. Do not include other payments like monthly utilities, car insurance, cell phone bills, insurance costs or day-to-day expenses.
Remember that the lower your debt-to-income is, the better rates and terms you will qualify for. And if you’re worried about your DTI being too high, follow our steps above to improve it.
We want to hear from you now! What questions do you have about DTI? Has a high DTI prevented you from qualifying for a mortgage? If so, how did you lower it? Let us know in the comments below!
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