When you apply for a loan, lenders will take a look at a variety of metrics to analyze your creditworthiness. From your credit score to your forclosure and bankruptcy history, various aspects are factored together to create a clear picture of your financial health. However, one of the most important is your debt-to-income ratio or DTI. If you’ve ever wondered what DTI is and how it affects your likelihood of getting a loan, you’ve come to the right place.
What Is Debt-To-Income Ratio?
DTI is a metric used by lenders to analyze your existing financial obligations, and how they weigh against your current income. Any form of debt or large ongoing payments you have may be factored in. For instance, a car loan, credit card debt, medical debt, student loans, or other property loans such as for an investment property will be looked at. Unpaid tax debt may also be factored in. These outgoing financial obligations are then weighed against your monthly income from all sources. DTI is valuable for lenders because it gives them an idea of the additional financial responsibilities you’d be capable of taking on.
What Does DTI Look Like in Practice?
To best understand how DTI works in practice, let’s take an example. Let’s say John’s bills breakdown like this: his car payment is $400, he also has student loan payments of $200, and his monthly credit card expenditures are $300. Lastly, his rent is $1,000 per month. John earns an income of $6,000 each month. If we add all of his expenditures and divide them by his income ($1,900 ÷ $6,000) we get a debt-to-income ratio of 0.31, or 31%.
What Is an Ideal Debt-to-Income Ratio?
Lenders have a DTI range that they’ll consider acceptable. Typically, a DTI of 43% is the maximum allowed to obtain a loan. Ideally, you want your DTI to fall below 36%. However, one caveat is that rent or mortgage payments are expected to account for no more than 28% of your total debt ratio. This consideration is to ensure that you have wiggle room to take on other debts that may arise.
How Can I Lower My DTI?
If you’re disappointed with your own DTI after calculating yours, it’s important to consider ways you can lower it. A lower DTI may help you secure more favorable rates as you’re seen as a more trustworthy borrower. One of the most obvious ways to lower your DTI is to focus on lowering your monthly payments. If your car is near being paid off, it might be best to do that before applying. Contact the billing departments of outstanding debtors to discuss methods of reducing monthly payments. You may be able to explore debt consolidation options as well, where you bundle high-interest debts into low monthly payments and pay several off at once.
Your DTI is a valuable metric to lenders big and small. Trying to balance your expenditures with income is crucial for your long-term financial planning. If you want an outstanding mortgage broker to help you work through the process, look no further than Federal Hill Mortgage. Apply today to get started.