Though there are many important factors to consider when filling out a credit application for a major loan or mortgage, your debt to income ratio (sometimes referred to as your DTI ratio) is among the very most important. It doesn’t directly affect your credit score but it is a key component of your credit health and your success at qualifying for major loans.
By understanding what a debt to income ratio is, how to find out yours, and what this means for your credit, you can increase your chances of qualifying for major loans and increase your overall credit health all at once. This information and more is discussed in greater detail below.
Debt to Income Ration Basics
To put it simply, your debt ratio is a number (a money amount) that is used by lenders to help decide how much of a risk you are to give a loan to. The number, your DTI ratio, shows these lenders how much debt you can handle (especially if you are already making regular monthly debt payments) and what sort of a credit risk you might pose.
Your debt ratio is calculated in such an easy way that you can even do it at home, by yourself. Simply divide your monthly income by your total monthly payments. Make sure that you include any minimum credit card payments that you have as well any student loan payments and auto loan payments. Factor in any of your other monthly (or regularly-based) debt obligations as well.
It is important to note that your credit report does not make any note of your monthly or annual income. This means that when you apply for a loan that requires your debt ratio on its application, the lender in question will need some sort of proof or evidence of your income. Much of the time a self-reported estimate is okay. However, sometimes documentation confirming the amount of your monthly income is required. This becomes more often the case the larger the loan that you are trying to take out becomes.
Once again, even though your ratio is not used to calculate your credit score in any way, it can have a major impact on your chances of getting new credit. For this reason, it is very important to consider highly.
You can use this debt to income ratio calculator to better help calculate your own DTI ratio.
Your Debt to Income Ratio and Your Credit
The main way in which your ratio impacts your credit is that it acts as an indicator of whether or not you will be able to (or have a history of being able to) repay your debts. Lenders place much importance on your DTI ratio for this reason. In addition to being a factor in whether or not you get a loan in the first place, your specific DTI ratio influences the actual interest rates that you will receive on your loan.
For instance, if you have a low ratio, chances are that you will be more likely to repay your debts. The reason for this is that you have the income to do so available to you. On the other hand, if you have too low of a debt ratio, lenders will feel that you might be overwhelmed by additional debt and that the chances of you making monthly payments are low.
What Your Debt to Income Ratio Should Look Like
Though every individual person’s debt versus income ratio will be different (based on their histories, finances, credit scores, and current debts), it is a standard rule of lenders that yours should be less than 36 percent.
In fact, most lenders require you to have less than a 40 percent DTI ratio to qualify for a major loan or mortgage. Even DTI ratios of 36 percent put you at a risk of paying very high interest rates on your loan repayments. And sometimes you might not qualify for the loan altogether.
Your chances of qualifying for a loan or mortgage get better the lower that your ratio is.
What to Do When Your Debt to Income Ratio is Too High
If you are considering (or attempting to) take out a loan or a mortgage, then having a high ratio can mean serious trouble. Luckily though, there are several things that you can do when your DTI ratio is too high.
The best (but unfortunately hardest) thing to do is increase your income. Many people can increase their incomes by taking on a second job, asking for a raise, or picking up odd jobs (such as lawn maintenance, pet care, child care) in your spare time.
You can also lower your debt versus your income ratio by paying off your debts. The lower the amount of monthly debt payments that you have to make, the better your ratio will be. You can pay off your debts using many different tactics.
It is very important to understand your debt to income ratio when applying for a major loan or mortgage. The information shared and discussed above will clue you in on the basics of what this ratio is, how it affects your chances at qualification, and what you can do to lower your own DTI ratio.