When it comes to accessing financial assistance, lenders need to make sure that you can make payments. Debt-to-income (DTI) ratio is one of the primary metrics lenders use to evaluate borrowers. It’s a percentage of your monthly income that goes towards debt payments each month.
DTI is a measure of your ability to repay your debt obligations. It combines the amount of your monthly debt payments with the amount of your monthly income. By calculating your debt-to-income ratio, lenders can determine whether or not you have the financial capacity to responsibly take on more debt.
How Is the Debt-to-Income Ratio Calculated?
Your debt-to-income ratio is calculated by taking the total amount of your monthly debt payments, including car loans, student loans, personal loans, and credit cards, and dividing it by your total monthly gross income (your pre-tax salary). This yields a percentage that expresses your DTI.
For example, if your gross monthly income is $5,000 and your monthly debt payments are $2,500, your debt-to-income ratio is 50%. This means that 50% of your income is already spoken for each month and there’s that much less money for other bills, rent, savings, and other essentials.
What Is a Good Debt-to-Income Ratio?
A good debt-to-income ratio is one that is considered as acceptable or manageable by lenders. Generally, lenders look for a DTI of 43% or less. This includes all of your monthly debt payments, from mortgage payments to student loans and credit cards. A debt-to-income ratio of 50% or more is considered high, and generally, lenders are unwilling to approve applicants with too high of a DTI.
But if you have a high DTI, all hope is not lost. There are still strategies for getting approved by a lender, such as lowering your interest rate or consolidating debt. Additionally, you can boost your income by taking on side gigs or finding a second job. Boosting your income can help to lower your DTI, making you a more attractive lending candidate.
Understanding Your Debt-to-Income Ratio
Your debt-to-income ratio is a key metric lenders use to assess the risk of lending money to you. A higher debt-to-income ratio may signal a higher risk of default, which may lead to lenders denying your loan application. But understanding and managing your DTI can help you get the financial assistance you need.
By considering how your debt-to-income impacts your ability to take on more debt, you can make smarter financial decisions and ensure your debt stays in check. Knowing your debt-to-income ratio is an important step in taking control of your financial future.