What’s Your Debt-to-Income Ratio?
Of all the terms you need to understand when it comes to managing your personal finance, debt-to-income ratio (DTI) is one of the most crucial. It’s also one of the most potentially confusing, as well! That’s why we’ve got just the facts you need to understand what your DTI is, what it means, and how you can use it as a tool for unlocking better financial health in the future.
Finding Your Debt-to-Income Ratio
In a nutshell, your debt-to-income ratio is a measure that keeps track of how much debt you’re carrying in comparison to the overall amount of money you make. Lenders use your DTI as a tool to determine if you’ll be able to make payments whenever you apply for a loan; if your DTI indicates that you’re not earning enough money to afford payments on additional lending, it’s unlikely that lender will be willing to extend you credit.
How Do You Calculate Your Debt-To-Income Ratio?
Thankfully, calculating your DTI isn’t nearly as complex as you might think it is. It takes a little math, but not much; all you’re doing is adding up all of your recurring monthly debt into one figure and then dividing it by the total amount of monthly income you receive. Here’s an example: your pay $1,000 a month in rent, $250 for your car loan, and $750 a month in credit cards, student loans, and miscellaneous debt. That adds up to $2,000 a month. If you earn $5,000 a month, then you would divide $2,000 by $5,000; that number is your DTI (in this case, 0.4).
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What’s a Good Debt-to-Income Ratio to Have?
As far as your lenders are concerned, a good DTI is one that’s as low as possible. This indicates that you have the financial resources to handle additional monthly payments without risking late payments or nonpayment. DTI is especially important to lenders when it comes to very large loans such as mortgages; while a mortgage lender will look at your credit score, your down payment, and other important factors like your credit utilization ratio and whether you have any bad credit, DTI is one of the biggest determining factors regarding the size of the loan you can receive.
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In most cases, lenders are keen to see a borrower’s DTI at 0.36 or lower, with only around 28 percent of that debt consisting of a mortgage repayment. However, many lenders will consider a DTI of as high as 0.43 for mortgage borrowers; a ratio any higher than that indicates that a borrower is trying to bite off more than they can chew when it comes to the cost of their housing expenses versus their current income.
How to Improve Your DTI
As your debt-to-income ratio is dependent on just two factors, it’s relatively simple to improve your DTI. In this case, you need to either reduce the amount of debt you’re carrying or increase the amount of income you’re bringing in. This is, of course, easier said than done in many situations. Yet there are ways to accomplish improving your DTI by doing one, the other, or both.
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For example, picking up more hours at work will all increase your income, as will cutting down on unnecessary expenses such as eating out. Concentrating on paying down your debt or even taking out a debt consolidation loan with a lower overall interest rate will likewise help improve your DTI. However, the best way to have a positive impact on your debt-to-income ratio in the shortest amount of time is to both reduce your debt and increase your income as much as possible.
Remember: Not All Expenses Are Debt
Your debt-to-income ratio tells a clear tale when it comes to your ability to handle loan repayments, but it doesn’t tell the whole story. It’s important to remember that your DTI doesn’t necessarily take into account other monthly expenses that aren’t debt-related; utility bills, for example, aren’t considered debt, but you still need to pay them regularly. This means you need to factor in these additional expenses before you take out any new lending, especially if your DTI is already higher than you would like.
The Last Word on Debt-To-Income Ratio
While it’s not necessarily foolproof, your DTI is a useful tool that lenders use regularly to determine if you’re a suitable candidate whenever you apply for any type of loan. However, bear in mind that is just one tool of many that can be used to determine your financial health; other smart financial practices, such as budgeting, also play an important role. In the end, however, it’s extremely helpful to maintain as healthy a debt-to-income ratio as possible, as this will aid you in the future whenever you may need access to lending. Whether it’s a mortgage for a new home, a personal loan for a new car, or anything else, having a good DTI will make things much easier!
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