Figuring Out Your Debt to Income Ratio
DTI or debt to income ratio is the financial measurement in percentage form comparing your debt to your income. The lenders use these figures to check your ability in managing monthly repayments of loans to pay back your borrowed money. It is more likely for you to secure a new line of credit or loan when needed if you have lower debt to income ratio. This is why figuring out your debt to income ratio is essential before you start sending in your applications for loans or credit cards.
How to Calculate Debt to Income Ratio
- Add up all of your debt payments every month.
- Divide these debt payments by the monthly gross income you have or the amount you earn every month. DTI = monthly debt / gross monthly income
- Convert the answer that you get into a percentage to know your debt to income ratio.
If you want to determine your debt to income ratio, all you have to do is divide your debt payments per month by your gross income. These debt payments per month include mortgage or rent payments, personal loans, student loans, auto loans, credit card payments, and others.
For instance, if your total monthly debt is $1,500 and you have $5,000 gross monthly income, this will give you 30% debt to income ratio.
Importance of Figuring Out Your Debt to Income Ratio
Knowing your debt to income ratio is important since banks, as well as other lenders, use the number to determine the amount of debt that a customer can have before experiencing financial struggle. Lenders also use the number for setting a healthy amount of loan for the customer and lender alike to prevent financial risk.
Calculating your debt to income ratio can help you determine if you are comfortable enough in handling your existing debt and know if applying for a line of credit or loan suits you and your current financial health.
What Can Be Considered as Good DTI Ratio?
As far as your DTI ratio is concerned, it is better if you have a lower percentage. All lenders set their own requirements for the DTI ratio. This means that what can be considered as good DTI will depend on what you are specifically applying for.
The general rule of thumb here is that debt to income ratio of more than 36% usually signals lenders that a customer has higher risks of financial stress and shouldn’t be taking on more additional debt. Also, if you have plans to apply for a mortgage, the maximum debt to income ratio for most banks is 40%.
Ways to Improve Your DTI Ratio
After you calculate your DTI ratio and you learn that it is too high to be approved for credit, below are a few ways to help you make your debt to income ratio better before you apply for a loan.
- Lower your debt every month by paying off your credit cards or any other loans you have.
- Avoid taking any additional debt.
- Apply for debt consolidation loan for faster debt repayment.
- Ask for a raise, take a second job, or switch jobs to increase your current income.