Debt-to-Income Ratio: What Exactly Does It Mean?
So you’ve thought about it long and hard, and you’re finally ready to buy a home. Awesome! So now what? Well, you know enough to understand that you’re going to have to qualify for a loan, and that loan will last a long time. But what else do you need to consider? How much will you pay every month? What kind of down payment do you need? How will lenders know how much of a loan you can afford to pay back over the next 30 years? Well, one of the answers to that question lies within your Debt-to-Income ratio. Lenders will use this as one way of analyzing your capacity to pay your debts.
What Is Your Debt-to-Income Ratio?
So what is your Debt-to-Income Ratio? It’s calculated by taking all of your monthly debts (auto loans, credit card payments, student loans etc.) and dividing them by your total monthly income (before taxes). This will give you a percentage, which lenders use to see if you can handle a mortgage payment, and how big that payment might be. Depending on the type of loan you are going your debt to income should be under 42% but some loan types and stronger credit loans will allow for it to get upwards of 50%. Meaning if you make $5,000 a month (pre-taxes), your new mortgage payment and all your obligated monthly payments equal $2,500, your DTI would be a 50%. They don’t take into account, car insurances, income taxes, utilities, and other similar expenses.
Why is Your Debt-To-Income Ratio Important?
Your DTI ratio essentially tells lenders what kind of capacity you have within your income to take on more debt. If your ratio is low, that indicates that you have relatively low debt for income that you take in. This is a good sign; lenders like to see low ratios because it typically indicates that you can manage your monthly debt in comparison to how much money you bring in. AKA; you should be able to comfortably make your mortgage payment !On the other hand, a high Debt-to-Income ratio suggests that maybe you have taken on a lot of debt already in comparison to your income, and maybe you shouldn’t take on any more debt.
How Can You Improve Your Debt-to-Income Ratio?
If your DTI is higher than you’d like, don’t worry. You can change your ratio by either increasing your income or decreasing your debt. Try paying off one of your vehicle loans before applying for a home loan or double up your student loan repayment in order to pay it off more efficiently. Talk to your Loan Officer before you take any actions, they are the expert and the use of your cash can be critical to your approval. Alternatively, you can increase your income in order to lower your DTI. Make sure your lender knows about your bonuses and has your allowable income. Have you asked for a promotion at work recently? Are you comfortable with the payment and your lender is saying "NO," ask someone to co-sign for you.
Your Debt-to-Income ratio is a key factor in purchasing a home. Take the time to educate yourself and make the right moves to get yours to a level which will get you the loan to buy the home of your dreams.