Your debt to income ratio (DTI) impacts your eligibility for a mortgage.
While you may never have thought about this number before, it is basically a ratio that tells the lender how much you can afford to pay comfortably on a monthly basis.
It’s a very simple calculation and it demonstrates exactly what it says, the ratio, or relationship, between your total debt and your income. You know you need to make more money than your bills every month or you can’t pay them, right?
All the lender really wants to see here is that if you take on one more (large) payment, can you still afford to live comfortably.
Your DTI also tells a lender how risky it might be (or not) to lend you money.
Even when your DTI does not keep you from getting a mortgage, it can still affect the interest rate for which you qualify. The better (lower) your DTI, the better the interest rate you can potentially get.
If you are worried about your debit to income ratio and your ability to qualify for a loan, there are ways to change this number. We’ll talk more about that after we’ve done the calculations.
It’s a very simple calculation and it demonstrates exactly what it says, the ratio, or relationship, between your total debt and your income. You know you need to make more money than your bills every month or you can’t pay them, right?
All the lender really wants to see here is that if you take on one more (large) payment, can you still afford to live comfortably.
Your DTI also tells a lender how risky it might be (or not) to lend you money.
Even when your DTI does not keep you from getting a mortgage, it can still affect the interest rate for which you qualify. The better (lower) your DTI, the better the interest rate you can potentially get.
If you are worried about your debit to income ratio and your ability to qualify for a loan, there are ways to change this number. We’ll talk more about that after we’ve done the calculations.
ADD UP YOUR MONTHLY DEBT
Total all of your fixed monthly debts, including things such as:
- Monthly house or rent payment
- Minimum monthly credit card payments
- Student loans
- Auto Loans
- Other monthly loan payments
- Child support or alimony
- Other debts
DIVIDE BY YOUR GROSS INCOME (BEFORE TAXES)
Your gross income is the amount you get paid before taxes are removed from your paycheck. You’ll see this amount in Box 1 of a standard W-2 form or in Box 7 on a 1099.
Some examples of income might be:
Some examples of income might be:
- Wages
- Salaries
- Tips and bonuses
- Pension
- Social Security
- Child support and alimony
CONVERT YOUR ANSWER TO A PERCENTAGE
To convert to a percentage, multiply your answer by 100. Here’s a quick example.
Let’s say you have the following debt:$350 per month auto loan $550 per month student loans Your total debt = $300 + $350 + $550 = $1200/month
Let’s say you have gross monthly wages of $5000 plus $1000 per month child support.
Your total gross income is $5000 + $1000 = $6000/month
Divide your total debt by your total gross income = $1200/$6000 = 0.2
Multiply by 100: 0.2 x 100 = 20%
Your Debt to Income Ratio is 20% in this case.
Look what happens to that same calculation if you lower the total gross income to $4000 per month.
$1200/$4000 = 0.3
0.3 x 100 = 30%
In this scenario, your total Debt to Income Ratio is 30%.
When you make less money but have the same amount of debt, the DTI percentage goes up.
So, the higher the percentage, the greater a risk you are to a lender. It’s that simple!
Let’s say you have the following debt:
- $300 minimum monthly credit card payments
Let’s say you have gross monthly wages of $5000 plus $1000 per month child support.
Your total gross income is $5000 + $1000 = $6000/month
Divide your total debt by your total gross income = $1200/$6000 = 0.2
Multiply by 100: 0.2 x 100 = 20%
Your Debt to Income Ratio is 20% in this case.
Look what happens to that same calculation if you lower the total gross income to $4000 per month.
$1200/$4000 = 0.3
0.3 x 100 = 30%
In this scenario, your total Debt to Income Ratio is 30%.
When you make less money but have the same amount of debt, the DTI percentage goes up.
So, the higher the percentage, the greater a risk you are to a lender. It’s that simple!
How to Reduce your DTI
If you are concerned about getting a loan or just want to make sure that when the time comes, you get the best interest rates, there are some things you can do to improve your debt to income ratio.
- Pay down your monthly debts as much as you can. Instead of making the minimum monthly payments, pay as much as you can afford each month. Decreasing the amount of your debt will not only pay it off sooner, but it can save you money by getting you a lower interest rate on a long term loan, such as a mortgage.
- Reduce your credit card use. This goes hand in hand with paying down your monthly debts. It makes it easier to pay down your credit card if you aren’t adding new charges to it each month. Try paying cash for things you would normally charge. If you pay cash, it’s impossible to spend more than you have.
- If possible, don’t take on any new debts. This may sound simple, but so often we don’t even realize all the ways we are offered “loans” on a daily basis. That interest only financing at the big box electronics store is great, but it’s debt, even if it is 0% interest.
Understanding your debt to income ratio is easy, and while it is not the only thing a lender will look at it, improving it is always a good idea.
Did you know?
Did you know that your DTI cannot affect your credit score? That is because credit reporting agencies do not know your income, so they can never calculate this number.
