As you start getting older you may find yourself in need of a home loan, car loan or even a credit card. When going through the loan application process, there is a of questions that gauge your ability to repay the loan and a financial ratio that your lender will look for. That’s why understanding your debt-to-income ratio is essential in personal finance, especially when you’re just starting to acquire loans from a financial institution.
Your debt-to-income ratio (DTI) is the amount of your monthly debt payments divided by your total gross monthly income. Lenders tend to prefer lower DTIs because they indicate that you have a manageable debt level, while higher DTIs are less favorable because it indicates that there is a higher amount of debt compared to your total income. Additionally, knowing and understanding your debt-to-income ratio helps you make informed financial decisions, like budgeting for future expenses or determining how much debt you can comfortably manage without compromising your financial stability.
How To Calculate Your Debt-to-Income Ratio
When calculating your DTI, you must consider two main components: your total debt and your total gross income. Here’s how to do it:
- Gather your financial information: Collect all monthly debts, including any credit card payments, rent expenses, student loans and any other recurring debts.
- Calculate your gross monthly income: Determine your gross monthly income; this can include your salary, any bonuses you earn and all sources of income before taxes.
- Use the DTI Formula: The basic formula for calculating is:
DTI = (Monthly Debt Payments/Gross Monthly Income) X 100
This formula will give you a percentage representing the portion of your income that goes toward debt repayment. Let’s say, for example, your total monthly debt payments are $2,000 and your gross monthly income is $6,000, then your DTI ratio would look like this:
DTI = ($2,000/$6,000) X 100 = 33.33%
What Is Considered a Healthy DTI Ratio?
With respect to lending, every financial institution has their own ratio that is healthy. Generally speaking, a DTI ratio below 36% is considered healthy, with 28% or less allocated to housing expenses. A DTI ratio above 36% is reasonable, and anything over 43% could cause alarm for some lenders. Several factors determine a healthy ratio such as loan type, credit score and personal finances.
Your DTI ratio can significantly impact your loan approval odds and interest rates. Maintaining a healthy ratio is essential for financial stability and access to the best lending options.
How can I Improve My DTI Ratio?
When starting out, your DTI might be favorable, but as you acquire more loans it can be significantly impacted. As you continue to build your credit history, you may need to improve your DTI. Here are some strategies to help:
- Focus on reducing existing debt. Prioritizing paying down high-interest debt or consolidating debt can be beneficial. Small, consistent payments can make a significant difference over time.
- Explore ways to increase your income, such as taking on a side job or freelancing. Even temporary income that goes directly towards debt can positively impact your DTI.
- Monitor your ratio over time to ensure you’re on the right path. A lower DTI indicates better debt management, leading to better loan terms, lower interest rates and increased borrowing capacity.
Whether you’re just starting your lending journey or have a loan from us, we’re here to guide you. If you need help to quickly identify your DTI ratio, here is a calculator https://www.bankrate.com/mortgages/ratio-debt-calculator/. Once you determine your DTI ratio you may be ready for that new car or the opportunity to buy your dream home; that’s where we come in! If you are ready, give us a call at 1-833-372-4968 to speak with a loan officer today!