Debt To Income Ratio
Debt To Income Ratio Basics
Your debt-to-income (DTI) ratio is all your monthly debt payments divided by your gross monthly income. Lenders use the DTI ratio, along with credit history, to determine how well a borrower manages his/her monthly payments and whether has the ability to repay a loan. Each lender has their own debt-to- income ratio approval guidelines, with mortgage lenders having lower, more restrictive DTI limits than a personal loan lender.
Calculate Your Debt-To- Income Ratio
To make it easier for you to calculate your debt-to-income ratio, we have included one of our online financial calculators. To use the calculator, enter all your income sources, such as salary, child support and pension benefits, then all your debt payments, such as mortgage/rent, auto, insurance and credit cards.
The ratio (percentage) calculated will be the total of all your debt payments divided by your total income sources. The lower the ratio, the more likely a lender will approve your loan application.
As an example, a borrower with a combined monthly income of $5,000 with monthly debt payments of $1,800 (rent of $1,000, auto payment of $300, credit card minimum payments of $350, plus miscellaneous payments of $150) will have a DTI ratio of 36%.
Most mortgage lenders consider a DTI of 40% or more a sign of financial stress.
Lender Debt-To-Income Ratio View
The ability-to-repay rule is the reasonable and good faith determination most mortgage lenders are required to make that you are able to pay back the loan. Under the rule, lenders must generally find out, consider, and document a borrower’s income, assets, employment, credit history and monthly expenses.
A debt-to-income ratio of 43% is generally the highest mortgage lenders will accept for a qualified mortgage, which is a loan that includes affordability checks. FHA mortgage loans allow DTI ratios above 43% in some instances.
Personal loan companies often approve consumers with debt-to-income ratios of 50% or more, and some exclude mortgage debt from the DTI calculation. This flexibility exists since personal loans are often used to consolidate credit card debt.
For those borrowers with existing student loans, particularly Federal, Fannie Mae mortgage loan guidelines allow DTI ratios up to 50%.
Does It Affect My Credit Score?
While a lender includes your credit score as part of the loan evaluation process, your debt-to-income ratio does not affect your credit scores. The national credit-bureaus include your income in your credit reports but is not used by FICO and Vantagescore in their credit score calculations.
However your credit score will be affected by your credit-utilization ratio, which is indirectly related to your DTI calculation. This is the amount of credit you are using compared to your credit limits.
The credit agencies know your credit usage and available credit limits from your credit reports. Your credit score will be penalized if your credit utilization rate is more than 30%. Similar to your DTI ratio, lower is better.
The debt-to-income ratio calculator makes it simple to understand. To reduce your DTI ratio, you need to either increase your income (make more money) or reduce your debts.
Improving Your Debt-To-Income Ratio
To improve your debt-to-income ratio you can either increase your income, reduce your debt or a combination of both. Let us offer suggestions on how to reduce your debt.
Establish a spending budget. The calculator already provides you a good starting point since it already provides you a list of your debt account payments. Most importantly, stay within your budget.
Establish a plan to prioritize paying off your discretionary debt accounts. Order your discretionary debt accounts into two lists: a) by size of debt (low to high) and b) by size of interest rate (high to low). These lists correspond to the two general debt repayment methods: the “snowball” and the “avalanche”.
This prioritizing your debt payments ordered by size of debt account. You concentrate your budgeted total discretionary debt payments on paying off the lowest debt account while making the minimum payments amounts for the rest.Once the lowest debt account is paid off, you have achieved a “small physiological victory” and freed up that amount for paying the other debt accounts. This completes a full payment cycle.Then you reallocate the total discretionary debt payment budget, prioritizing the next debt account on the list while making the minimum payments amounts for the rest. This cycle continues, eliminating another debt account and freeing up that amount of payment for the remaining debt accounts.
This prioritizing your debt payments ordered by interest rate of the debt account. You concentrate your budgeted total discretionary debt payments on paying off the most expensive debt account while making the minimum payments amounts for the rest. Once the most expensive debt account is paid off, you have freed up that amount for repaying the other debt accounts. This completes a full payment cycle.Then you reallocate the total discretionary debt payment budget, prioritizing the next debt account on the list while making the minimum payments amounts for the rest.
Reduce the cost of servicing your debt. Of your debt accounts, credit cards generally have the highest interest rates along with late payment fees and related charges. If your credit score allows, you have several options:
Negotiate lower interest rates with your existing lenders. If you are a good customer and have consistently paid your accounts on time, your lender may wish to keep your business.
Open a low-interest balance transfer card to consolidate credit card accounts. Use the promotional period of the balance card to prioritize repayments against the principal of the debt.
Get a monthly, fixed payment personal loan to consolidate credit card accounts. The interest rate of the personal loan must be less than the weighted average of the credit card accounts being consolidated.
Avoid taking on more debt. You cannot reduce your debt-to-income ratio unless you reduce your debt. Don’t add to your problem. Be focused and disciplined.
Your debt-to-income (DTI) ratio is all your monthly debt payments divided by your gross monthly income. Lenders use the DTI ratio, along with your credit history, to determine how well you manage your monthly payments and whether you will be able to repay a loan.
An overview of debt-to-income (DTI) ratio is presented. This includes 1) What Is It; 2) How It Is Calculated; 3) How A Lender Uses the DTI Results and 4) What Reductions In Your Discretionary Expenses Can Be Made.
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