What you need to know about the debt-to-income ratio
What is a debt-to-income ratio?
Your debt-to-income (DTI) ratio compares the amount of debt you have to your overall income. Some people say that this number is just as important as your credit score, especially when you are applying for a mortgage, because lenders look at this ratio when deciding whether or not they are going to allow you to borrow money.
Your ratio will help your lender decide if you are a low-risk or a high-risk borrower. This assessment helps ensure that you are not taking on more debt than you can handle and will not be a potential liability to their business.
What is a good debt-to-income ratio?
While each lender sets its own DTI requirements, the maximum debt-to-income ratio you can have while still meeting the requirements for a qualified mortgage is typically 43%. However, a good ratio is usually thought to be at or below 36%. Having a DTI of 36% gives you a little more flexibility in case of a sudden change in your income and/or expenses. Of course, the lower your ratio is, the better it is when you’re applying for a loan.
How do I calculate my debt-to-income ratio?
To calculate your DTI, begin by adding up your monthly bills. These may include your monthly rent or house payment, child support payments, student and/or automobile loans, credit card payments, and any other debts or regular payments. Expenses such as groceries, utilities, and taxes are usually not included. Then, take that number and divide it by your total gross monthly (your income before taxes).
The resulting number is your debt-to-income ratio, expressed in the form of a percentage.
How do I lower my debt-to-income ratio?
To lower your DTI, you either need to increase your income or decrease your monthly payments. To increase your income, you may want to think of pursuing a second job or asking for a raise, keeping in mind that lenders typically look at your last two years of income history. To decrease your payments, try to pay off any loans, think about refinancing your loans, or consolidate your debt. A good place to start is paying off your smallest outstanding loans first, in full.