Debt to income ratio (DTI) is a financial tool that helps lenders assess your ability to make payments on a new loan. It helps them determine whether you’re a risky borrower who might not be able to make timely payments. The higher your DTI, the more likely you are to face a higher interest rate, or to be declined for a loan. When you know your DTI, you can make sure you’re prepared to handle any challenges that may arise. You’ll also have a good idea of whether it’s a good idea to take on new debt or to refinance an existing loan.
Your DTI is based on a calculation that combines your monthly mortgage payment and all of your other payments. This includes things like credit card bills, auto loans, and other types of loans. In addition to calculating your debt to income ratio, lenders also consider other factors such as your credit history and employment status. They may require that you improve your income before they approve you for a new loan.
Lenders can calculate your DTI by subtracting your monthly debt payments from your monthly gross income. For instance, if you earn $7000 a month, your debt to income ratio will be 32%.
A high debt to income ratio isn’t necessarily a bad thing. However, lenders view a high DTI as a sign that you’re a risky borrower. High DTIs can put you at risk for expensive home loans or restrict your eligibility for other loans. Therefore, a low DTI is a sign of a healthy balance between debt and income. While a high DTI can make it difficult to qualify for a loan, a low DTI can mean you’re a good candidate for a new loan.
There are two types of debt to income ratios, front-end and back-end. Front-end is the most common type of DTI. It’s calculated by adding your monthly mortgage payment, along with other mortgage-related expenses, such as property taxes and homeowners association dues. Also, if you’re living in a rental property, your housing ratio will be taken into consideration.
If you’re wondering how to calculate your DTI, you can use a debt to income calculator. It will calculate the amount of money you have left after putting your minimum payments on your mortgage, your car loan, your student loans, and other payments. That figure will then be multiplied by 100 to get your percentage.
For example, if you’re earning $5,000 a month and you make $1,000 a month in mortgage payments, you’ll have a front-end ratio of 20%. However, if you’re making $2,000 a month in mortgage payments and $200 a month in other payments, you’ll have a back-end ratio of 40%. Having a DTI over 50% means you’re a risky borrower, so lenders will often charge you a higher interest rate or deny you a loan.
Debt to income ratios above 50% can also signal that you’re struggling to keep up with your debt obligations. In this case, you might want to reevaluate your debt management or look into credit counseling or consolidation to help you pay off your debt faster. By reducing your debt, you can increase your income, which will ultimately decrease your debt to income ratio.