Category Archives: Debt to Income Ratio

Learn how to calculate your debt to income ratio

Many financial institutions will first do a credit check on you and then calculate how much your debt to income ratio is before lending you their money. You can check your own debt to income ratio before applying for a loan. Follow these steps and know your debt to income ratio.

debt_to_income_ratioFirst you need to figure out your gross monthly income. You will find it in your pay stub or in your leave and earning statement. You can also use the W-2 form given at the end of the year by your employer.

Then you need to calculate your minimum monthly payments that you do towards your debts. Go through all your monthly bills and statements to calculate the minimum due each month. You can also check your credit report to calculate your minimum payments for each month. If you don’t have a copy of your credit report, you can get a free copy once in a year from all the three credit bureaus.

Once you know the gross monthly income and your total minimum payments of your debts, divide your total minimum payments by your gross monthly income.

  • For example:

Total Minimum Monthly Payments (debt) =$1,000

Gross Monthly Income (income)=$2,000

Divide $1,000 by $2,000 =.50 or 50% debt to income (D/I) ratio

According to this example, 50% of your money goes towards paying your debts. It must be a great feeling for you. If you have a 100% debt to income ratio, this means that you have no money left for your essential needs like food, clothing, etc. Having 50% of the debt to income ratio means that you are living paycheck to paycheck, but you are able to pay all your bills on time every month, go for an outing once in a while, or go on vacation. These numbers are perhaps good.

Calculate-Your-Debt-to-Income-RatioWhen you apply for a new credit with this debt to income ratio, many financial institutions know that you need some debt in order to rebuild your credit scores. They prefer your debt to income ratio to be below 50%. An ideal number will be below 30% and 10% is the best because this means that you have more money available to pay back your loans.

Be careful of the lenders who are willing to loan you money even if you have a very high debt to income ratio. They are going to charge you a lot of money in very high interests and fees and it will be very difficult to pay them back. You can always shop with different companies and see what their terms are in offering a lower interest rate loan.

  • Resources:

http://www.consumerfinance.gov/askcfpb/1791/what-debt-income-ratio-why-43-debt-income-ratio-important.html

What is a debt to income ratio (DTI) and how is it calculated

One of the important criteria in order to get approved for a mortgage loan is to have a low debt to income ratio (DTI) other than having good credit scores. When a bank is reviewing your loan application, they will look into three main areas while reviewing your credit history. First, they will check your credit scores. This is the most important factor in getting approved for a home loan. They will also look into your current income and your job history.

If someone who is just 19 years old is applying for a home loan with a credit score of 800, he will not get approved just because of his good credit scores. The banks will look at the debt to income ratio and job stability just as much as the credit scores.

Debt to income ratio is simply the ratio between a person’s earning and how much they pay monthly in installments and revolving debt. For example, if a person earns $4000 in a month and out of this, $2000 is spent in monthly expenses like rent, car payments, credit card payments, then his debt to income ratio is 50%.

Banks will prefer approving the loan applications of those people whose debt to income ratio is as low as possible. This way, they will feel assured that the borrower is going to make his mortgage payments without any default. If his debt to income ratio is high, then there are greater chances of his defaulting on the payments.

A large number of people have a revolving debt account. This account is like a credit card and it has no end point to the debt. It’s an open ended line of credit. The debts can be fluctuating. They can be very high on a certain month and very low on the other month. They keep on revolving every month.

Installments debts have a predetermined time line. Certain kinds of debts like car payments, home loans, student loans fall under this category. These kinds of debts can be “re-charged” or increased once the terms have been set by the lender. The loan amount keeps on decreasing on an installment basis.

So when calculating one’s debt ratio (DTI or Debt Ratio) banks typically won’t allow you to pay down revolving debt in order to qualify. This is because one can easily re-charge the revolving account back up after the new loan is issue. However, the banks will allow you to pay off installment debt since it has a specific time period and cannot be recharged.

Debt to income ratio will also get affected by student loans. If you have applied for a deferment on your student loan, it will lower the debt to income ratio. This is a debt in any case, even though it can be paid later at lower interest rates.

Now you can see there’s more to getting approved for a mortgage loan than just having good credit scores. Other than having good credit scores, one of the biggest criteria is having a low debt ratio (DTI).