The debt-to-income ratio is a financial indicator used by lenders to determine your borrowing capacity. It combines all of your monthly payments – including your mortgage, car loans, credit card bills, student loans, and child support – into one single percentage. This can help you decide whether it is worth taking on another payment, or if you can afford a new line of credit.
A healthy debt-to-income ratio is less than 50 percent. Having a DTI that exceeds that mark can leave you in debt and facing potential late fees or denial of a loan. If you are close to this amount, consider consolidating your debts. When you have paid off your debts, your DTI will drop to zero.
You can calculate your own debt-to-income ratio by dividing your total monthly debts by your gross monthly income. For instance, if you have $2,000 in monthly payments, then your debt-to-income ratio will be 2%. Generally, it is best to calculate your ratio on a monthly basis. However, you can also calculate it yearly.
Debt-to-income ratios are typically expressed in percentages, and lenders often prefer to see a higher ratio. In some cases, a lower ratio is a better deal for the lender. Keeping your debt-to-income ratio low will help you avoid paying high interest rates, and will give you a more positive credit history.
There are two types of debt-to-income ratios: the front-end and the back-end. The front-end ratio is also called the housing ratio. Lenders evaluate this by looking at how much you spend on housing. These expenses include your home mortgage, homeowners insurance, property taxes, and monthly home association fees. They do not count utilities and groceries.
Similarly, the back-end debt-to-income ratio looks at your non-mortgage debt. Often, this includes revolving debt, such as credit card balances. It should be fewer than 36 percent, or the lender may deem you a high risk.
While these two ratios can vary, they are both valuable indicators of your financial health. Taking the time to monitor your debt-to-income ratio can help you determine your borrowing capabilities and make smart buying decisions.
Depending on your goals, a healthy debt-to-income ratio can be a simple as a low number, or it can be a complex equation involving a variety of factors. If you have a lot of debt, however, keeping your ratio low can be a difficult task. And it can be hard to know how much room you have to scrimp.
One way to reduce your DTI is to take on a part-time job. Even if you are currently working full-time, you can earn hundreds of dollars by doing something such as babysitting or handyman work. Also, you can earn extra money by offering rides for a local Facebook group or community event.
Another factor to consider when calculating your DTI is your credit score. Credit scores are based largely on the “amounts owed” portion of your credit history, but there are many other factors to consider.